The year 2011 proved fascinating for Asia, with the region consolidating its role as the essential player driving global economic recovery.

But 2012 promises to be more fraught as domestic politics take command amid new challenges to growth. A number of risks, opportunities and emerging patterns will shape Asia during the next 12 months and beyond.

One lesson of Europe’s current struggles is that politics matters deeply to choices about the EU’s economic and financial future. Asia is not Europe, of course, but its politics will matter greatly in 2012. Electoral outcomes and succession arrangements are likely to roil markets, bring to power governments more (or less) committed to institutional, regulatory and trade-related reforms, and possibly yield greater international tension. Three elections — in the US, South Korea and recently in Taiwan — feature candidates and parties with distinct policies and priorities. China will also complete a scheduled leadership change. And North Korea’s elite, whose members aim above all to preserve their own power, must now navigate an earlier-than-expected transition that could yet produce infighting and vast new challenges for Pyongyang’s neighbours.

Thailand also bears watching, as former Prime Minister Thaksin Shinawatra looks to return from exile. Such political risks will likely intensify well into 2014, when India and Indonesia hold elections. A possible return to Golkar rule in Indonesia, in particular, could slow institutional and policy reforms there. The year 2012 should be another rough time for Afghanistan, Central Asia and Pakistan. War, terrorism, narcotics and weak political institutions continue to steal headlines. But the region’s future will depend as much on whether governments improve their poor macro- and microeconomic fundamentals and expand opportunity, although economic change will remain elusive unless these states better cooperate in 2012. Meanwhile, Pakistan’s economy has considerable potential. But the country lacks a credible growth strategy. Islamabad will remain burdened by a high debt-to-GDP ratio that crossed 60 percent in 2010, painful debt service obligations to its creditors, a large fiscal deficit, double-digit inflation, a depreciating rupee and a trade deficit worsened by high global commodity prices. These economic realities will compound intensifying political risks in Pakistan.

Much was made in 2011 of Washington’s supposed strategic ‘pivot’ to Asia. A bigger issue for Washington’s partners in Asia is that the US, for all its strengths, still does not have its economic act together. Thus the principal strategic issue for most in Asia is whether America restores its economy and addresses its fiscal deficit and growth outlook. The weaker America’s fiscal and economic position becomes in 2012, the less relevant the US will be to Asia’s future.

Asia even managed to sustain robust growth amid austerity in Europe and sluggish growth in the US. But new challenges are emerging for the region’s most export-dependent economies. The markets will watch China especially closely — along with the US and the EU — because the world economy can hardly afford to have its three principal growth engines facing a crisis simultaneously. Beijing’s landmark Twelfth Five-Year Plan deliberately aims to achieve slower but more balanced growth. But such structural adjustments will come only gradually, and, in the meantime, China’s economy continues to rely on exports and investment in fixed assets. Others, such as South Korea, will also be vulnerable in 2012. They have relied, in part, on Chinese demand to power their economies, so even a modest slowdown in China will have contagion effects elsewhere in Asia.

India will grow robustly, but more slowly, in 2012. This is only one of many sources of gloom. Tax, pension and FDI reforms have all stalled, and parliamentary business has been tied up in knots as the leading national and regional parties squabble. Mumbai’s SENSEX stock index was the world’s worst major performer in 2011, declining from 20,561.05 on 3 January to 15,175.08 on 19 December. And bellwether state elections, especially in Uttar Pradesh, are almost certain to make the major parties even more cautious when considering any major reforms. Similarly, slow progress on economic reform may limit other countries in Asia in 2012. In Vietnam and Indonesia, FDI, regulatory or financial reforms have largely stalled and show little sign of revival. Still, one bright spot in 2012 may be Malaysia, which has begun to shed elements of its 1970s-era ‘New Economic Policy’.

By far the biggest question mark about reform though is China, with resistance to change anchored in interest group politics. Chinese leaders, as cautious technocrats, tend to split the difference between competing groups in China’s increasingly pluralistic polity. The result has been a strong bias toward incremental policy change rather than bold reforms. We will also learn much more in 2012 about the sincerity of reforms in Burma. Another question mark will be ASEAN’s response to Burma’s apparent change of direction. Balancing the role of great powers to the north — China and Japan — has long provided an impetus to ASEAN community building, with founding members hoping for a cohesive force to help balance China in particular. But Burma has stubbornly resisted ASEAN ways. With Naypyidaw now scheduled to assume the ASEAN chairmanship in 2014, regional heavyweights will face tough decisions about how hard to push the regime.

In recent years, Preferential Trade Agreements (PTAs) have proliferated in Asia. The US entered the trade fray in 2011 by more fully embracing the Trans-Pacific Partnership (TPP). In my view, the TPP has considerable potential. Beijing has criticised the TPP as part of a US strategy to ‘contain’ China. Yet it has also promoted its own brand of PTAs across the region — with ASEAN, Pakistan, Singapore and others.

While protectionist pressures will likely rise in 2012, so too will the tolerance for trade conflict, particularly in Washington and Beijing. China has grown more comfortable with the WTO’s dispute-resolution procedures. And, having learnt to leverage the system to its own advantage, Beijing is vigorously fighting US suits in many areas. For their part, US political and business elites are certain to complain ever more loudly about Chinese currency, intellectual property, procurement and cyber-related practices. Most in Asia will watch warily, fearing greater protectionism. But some will jump on the bandwagon: India has already initiated 149 anti-dumping cases against China.

Politics, economics and security are increasingly in collision in Asia. The US continues to provide Asia’s principal security-related public goods through its forward-deployed military presence and role as a strategic balancer. But Asian economies will increasingly provide one another with their principal economic-related public good — namely, the demand that can provide a pathway to sustained economic growth. This collision between economics and security may well intensify in 2012.

Evan A. Feigenbaum is Adjunct Senior Fellow for East, Central and South Asia at the Council on Foreign Relations.

A version of this article was first published here on the Council on Foreign Relations Asia Unbound blog.

1. Will Asia step up to the global challenges of 2012?
2. Asia, Europe and regional cooperation in 2012
3. Russia in the Asia Pacific: a bleak outlook

India’s economy was one of the earliest to stage a turnaround after the global financial crisis.

The decisions taken in early 2008 to increase public-sector wages, forgive loans for farmers who had borrowed from the banks, and massively expand the rural-employment guarantee scheme assisted the economy before the global financial crisis unfolded in the last quarter of the year. Not surprisingly, India staged its recovery within two quarters of the crisis striking, as economic growth accelerated from 6.7 per cent in 2008–09 to 7.2 per cent in 2009–10 and 7.5 per cent in 2010–11. Most forecasts for 2011–12 predicted over 8 per cent growth. But the economy has shown significant signs of slowing down. With the economy growing at about 6.9 per cent in the second quarter of 2011, and the November estimates of industrial production showing over 5 per cent decline, it is now expected that the growth rate for 2011 may even fall below 7 per cent.

The moderation in India’s economic growth rate was not the only matter for concern in 2011. The economy possesses a number of structural imbalances, and no effective mechanisms have been put in place to correct them. The government has not been able to control fiscal deficits at the budgeted levels and it is now expected that the central government’s fiscal deficit will be about 5.5 per cent of GDP and the consolidated fiscal deficit around 8 per cent. With the annual losses of state electric utilities amounting to 1 per cent of GDP, the government’s overall fiscal situation is not much different than it was at the beginning of the decade. Providing for additional expenditure commitments in education, healthcare and food security will be a daunting challenge over the coming year — especially when combined with the political difficulty of phasing out ill-targeted subsidies and achieving fiscal consolidation in the medium term.

There are worries on the balance-of-payments and inflationary fronts as well. The virtual stagnation of the global economy has resulted in stagnating exports for India, and as crude oil prices remained elevated throughout 2011, a high growth in imports also continued. With exports even slowing in the services sector, India’s current account deficit is likely to touch 3 per cent of GDP. In normal times, this could have been managed with capital inflows, but, with foreign institutional investors shying away from India, financing a deficit of this order will pose problems. Not surprisingly, the value of the rupee plummeted by over 20 per cent in the last few weeks, and even with the Reserve Bank of India in possession of reserves surpassing US$300 billion, a significant depreciation of the rupee could not be prevented. In the next six months, India will have to repay foreign loans of over US$140 billion, but problems may arise if the lenders refuse to roll over the credit. In addition, the inflation rate for 2011 is likely to be close to 10 per cent, and the rupee’s falling value has not helped matters.

The major concern for 2012 is the government’s apparent inability to forge political consensus and enact reforms which could bring in FDI and institutional investment. The last few months have raised serious questions about the government’s ability to carry forward much-needed reforms. These issues of governance — teamed with the inability to phase out subsidies or achieve fiscal consolidation — and India’s ‘policy paralysis’ in several areas are serious cause for worry. But crisis is the mother of reform, and the difficult situation should force the Indian government to act. The government has an 18-month window to carry out reforms before electoral politics overtake policy making. Hopefully, it will muster enough support by forging consensus on important economic reform policies, remedy the structural imbalances and revive the economy to reach the trend growth rate of over 8 per cent.

M. Govinda Rao is Director at the National Institute of Public Finance and Policy, New Delhi, and a member of the Economic Advisory Council to the Indian Prime Minister.

This article is part of a special feature: 2011 in review and the year ahead.

1. The Eurozone crisis and prospects for India
2. India: The discipline of liberalisation
3. Incredible India? Complicated India

The global financial crisis and the climate crisis are twin concerns: we cannot solve one without solving the other.

Green growth must be recognised as part of the solution to the current global financial crisis. To overcome these dual problems, both developed and developing countries should progress to a greener model of development, and move beyond traditional ways of thinking about these issues.

The global financial crisis is to some extent a crisis of the traditional development model that brought prosperity to the industrial world and which is now bringing ‘prosperity’ to the emerging world. Consumers in industrialised nations devour cheap goods that are often produced by developing countries in an emission- and resource-intensive way. As a result, developing countries achieve rapid growth through producing and exporting these emission-intensive goods. On the surface, it looks like a ‘win-win’ situation; the industrial world has high standards of living, and the emerging world has impressive GDP growth, foreign reserves and sovereign bonds. But this results in global imbalances, and these in turn have led to the global financial crisis. 

There are two major reasons why green growth is difficult in this context. First is the failure of conventional analysis on climate change. This analysis sees carbon mitigation as conflicting with economic growth. It fails to recognise the possibility that mitigation may drive the economy to become even more competitive, such that countries undertaking strict mitigation policies will benefit economically. In this sense, mitigation could become a form of self-interested behaviour for key countries. Second, since green growth is not yet a widespread reality, policy makers usually see ‘green’ as a risk and are reluctant to take decisive action.

But mitigation and green transformation represent enormous opportunities. Green transformation is a comprehensive and fundamental transformation of the development pattern established during the Industrial Revolution. It includes social, economic, environmental and political transformations — not just the adoption of a few cutting-edge green technologies, as some seem to think.

Responding to doubt over green-growth potential requires us to revisit old energy debates. Most economists are not concerned about the eventual exhaustion of fossil fuels, since based on economic logic they believe there will be a strong incentive to invent or find alternative energy when fossil fuels begin to run out. These incentives will guarantee green growth in the future. But now, with the current climate and financial crises, we cannot afford to wait for green growth to occur organically further down the track — we need immediate action to find solutions. Global carbon mitigation will ensure the ‘natural process’ of green growth happens earlier, and this new reality must be addressed within established energy narratives.

In China, more and more people have realised the opportunities green growth represents. Green transformation is not just seen as a burden — it is also seen as a new source of growth. Compared to industrial economies, which to some extent are locked into a high-carbon economic structure, China can still gain the ‘late-comer’s advantage’ in avoiding lock-in effect and promoting green growth. This is the key message in a forthcoming green-growth report being jointly produced by the Development Research Centre (the Chinese government think tank) and the World Bank. And affected as we are by these twin crises, the world urgently requires a new breed of great thinkers and visionary politicians who are capable of moving beyond the current economic and political rut.

Yongsheng Zhang is Senior Research Fellow at the Development Research Centre of the State Council, China.

1. Financial crisis an opportunity to move on climate change
2. Financial crisis driving emissions up or down?
3. Climate finance: Getting to $100 billion a year by 2020

The Philippines began 2011 with high expectations and optimism after the Aquino administration announced various reform-minded plans and programs.

These included a vigorous anti-corruption campaign, plans for greater government transparency and accountability, a number of public-private partnerships (PPPs) for major infrastructure projects, social programs addressing poverty alleviation, and improved education and health programs.

Still, the national economy slowed down in 2011 as compared with 2010, which was a year of high election spending. In 2011 there was no compensatory infrastructure spending because many (10 or so) PPP projects were not yet ready. This under-spending in public construction resulted in a lower budget deficit (around 2.5 per cent of GDP) — and with the lowering of the budget deficit and the build-up of reserves, rating agencies improved their outlook on the Philippines.

Remittances from overseas workers increased, and business processing services grew vigorously by about 20 per cent. Consumption demand, which has a high import component, was maintained largely due to remittances. Private-sector construction also remained strong. But excessive rains and flooding; supply chain disruptions caused by calamities in Japan and Thailand; and the economic slowdown in the US, Europe and Japan greatly reduced electronic exports. Thus the growth rate for 2011 will probably be about 3.7 per cent, as compared with government targets and estimates of 4.5 per cent.

Interruptions in the supply of essentials brought about by typhoons and flooding, and the increase in fuel prices upped headline inflation to slightly over 5 per cent, but core inflation remained at 4.5 per cent on average.

In the political domain, the House of Representatives passed a resolution impeaching the Chief Justice in December, and thus 2012 will start with the Senate conducting a trial into his alleged violations of the constitution and betrayal of public trust. The trial will attract plenty of public attention and time, and probably cause a lot of distraction. Speculation as to the outcome will also have consequences in both the public and private sectors. For example, if the Chief Justice is impeached, who will be next? Or if the Chief Justice is acquitted what will the President do? Will there be a constitutional crisis? Despite this trial, I remain hopeful that the first half of 2012 will see the much-awaited start of a public infrastructure program to boost economic growth over the medium term.

Philippine population growth remains high in comparison with other Asian countries, but unemployment and underemployment also remain high, and around 26 per cent of the population remains in poverty — the poor being mostly in the country’s rural areas where agriculture has not kept up with demand. In fact, the Philippines has become a large net food importer since 1990. The comprehensive agrarian reform program instituted in 1988 did not raise productivity because of the lack of support services, although the government made large outlays for compensation to former landowners and credit support for former farmer beneficiaries. The Comprehensive Agrarian Reform Law expires in August 2014. I hope that corporate farming will then improve food production and reduce poverty in the countryside. More flexible labour laws would also enhance employment for qualified individuals and could increase family incomes.

Globally, the situation is not encouraging; Europe, Japan and the US still face very challenging economic, financial and political problems. The Philippines is not immune to the effects of these global problems; the question is the degree of its vulnerability. The Philippines’ exposure to European credit is quite low and a credit squeeze there will likely have little effect. On the other hand European exposure in the Philippines — in both the private and public sectors — could be sold in the market and be picked up by other international or Philippine institutions.

The performance of the Philippine banking system has improved, with low levels of non-performing loans, and a high capital-to-asset ratio of about 16 per cent. The banking system is therefore geared to support working capital requirements and the further expansion of facilities and infrastructure — particularly power projects to meet capacity requirements by 2014. The Central Bank of the Philippines is even contemplating implementing Basel III ahead of time in order to remove further uncertainties.

The Philippine balance of payments has improved over the past years such that gross international reserves now exceed external debt, making the Philippines a net creditor nation. As a result, the country has enjoyed improved ratings, a capital inflow of portfolio investments, a slight strengthening of the peso, low interest rates and the enhancement of the longer-term peso bond market. Each of these improvements has made it possible for financial institutions to lend longer for housing and infrastructure financing.

While Asian growth will decelerate, it will still remain positive — slightly above 7 per cent. Thus it is anticipated that the Philippines can continue exporting to neighboring countries — especially China.

All these things considered, the Philippines seems likely to have a positive growth rate of about 4.5–5 per cent in 2012 as the government begins to implement projects and facilitate investment.

Cesar Virata is Principal of C. Virata & Associates and is a former Prime Minister of the Philippines.

This is part of a special feature: 2011 in review and the year ahead.

1. The Philippines: Weak institutions drag on economic performance
2. Why has the Philippines lagged?
3. Poverty and growth in the Philippines

South Asia is a vast region encompassing eight nations (if we include Afghanistan) and over one-fifth of humanity.

It is difficult to do it justice in this short summary of the year’s events.

Foremost among the region’s significant developments is the killing of Osama bin Laden in a US raid on 2 May. This is important not just for its effect on al-Qaeda, but because it made possible Washington’s claim that the US could now leave Afghanistan with its ‘mission accomplished’. By the end of 2014 there will be only a rump of about 20,000 NATO troops remaining.

At the same time, the raid also triggered a marked deterioration in the US-Pakistan relationship, already troubled by the Raymond Davis affair. The net result is that although the impetus on the US to leave Afghanistan has increased, the prospect of an orderly departure and satisfactory final outcome has declined.

The introduction of a ‘strategic’ element to the India-Afghanistan relationship during President Karzai’s New Delhi visit in early October and the NATO attack on a Pakistani border post in November — in which 24 Pakistani soldiers were killed — further diminished prospects for a peace based on compromise. Following the incident, Pakistan boycotted the vital Bonn conference on 5 December and closed the Pakistan-Afghan border to NATO supplies. Pakistan’s uncertain role was highlighted by President Zardari’s failure to return from Dubai in a timely manner following medical treatment.

In the worsening climate, Pakistan drew still closer to China. Islamabad not only assessed that the US relationship is a political millstone round its neck, but also that the US is a diminishing regional power — at the same time as China is rising.

On a brighter note, in early November Pakistan agreed to grant India most favoured nation status in trade, which India accorded Pakistan some years ago. Trade is still miniscule, and given cross-border tensions is unlikely to lift significantly in the near future. But the decision is symbolically important.

In India, growth slowed and inflation soared, exacerbated by a steadily falling rupee, such that by year’s end, there was a risk that India — which is heavily dependent on foreign capital to support its twin deficits — might become caught up in the investor caution now affecting Europe.

Politically too the Indian National Congress-led United Progressive Alliance has suffered from the widespread perception that it is even more corrupt than previous Indian governments. The massive 2G telecommunications scam was central to this perception. The corruption issue has paralysed the operations of Parliament at a time when urgent economic reforms are needed — for example, derailing efforts to introduce a 51 per cent FDI regime in retailing.

This highly negative climate for the government is background to the state-level elections in Uttar Pradesh, scheduled for 2012. These elections in India’s giant state are considered a bellwether for national elections in 2014.

India’s troubled relationship with China has not significantly improved over the year. Following New Delhi’s decision to allow the Dalai Lama to speak at a conference in the capital, China cancelled the 2011 border talks, scheduled for 28–29 November. Despite this, military-to-military relations are to resume, following India’s previous decision to cancel ties over the Kashmir visa issue.

Meanwhile, Nepal has bowed to Chinese pressure and is now allowing far fewer Tibetans to cross the border. The Maoists and their moderate opponents also failed to reach a compromise in the stalemate over the induction of an estimated 19,000 Maoist fighters into the army. Until Nepal overcomes this stalemate, it will continue to delay the long-awaited new constitution, instability will persist and the economy will languish.

Despite the fact that the normally pro-India Awami League is currently in power in Bangladesh, water continues to be a sensitive issue between Dhaka and New Delhi, primarily owing to the traditional row over sharing the Ganges’ water, but also because of Indian proposals to build a dam in Manipur. Bangladeshi irrigators are suspicious that the run-of-river hydro scheme will diminish their access to water, and the issue has become highly sensitive for the ruling party, often accused by the opposition of ‘selling out’ to India.

Against this troubled background in South Asia, Sri Lanka has had a relatively stable year. The Rajapaksa government continues to tighten its hold in the aftermath of the civil war, shrugging off international efforts to draw attention to alleged human rights abuses. They are assisted at home by the fact that Sri Lanka’s economic position is enviable, with an estimated growth rate this year of 8.5 per cent.

Sandy Gordon is a Visiting Fellow at RegNet, College of Asia and the Pacific, the Australian National University.

This is part of a special feature: 2011 in review and the year ahead.

1. The South Asia Cold War ‘quadrilateral’ redux?
2. US-India relations: Problems posed by Afghanistan and Iran
3. Some thoughts about the South Asian ‘region’

A great deal in the international economy is riding on what happens to the Chinese economy in the new year.

 China’s 9 per cent plus growth since the global financial crisis has been a central element in Asia’s bucking the global recessionary trend. With Europe still in trouble and the United States struggling to keep recovery on track, is China too now destined for a hard economic landing?

In the first of our annual year-in-review series, Yiping Huang suggests that 2012 will not be a replay of 2009, with neither a hard landing nor a sharp rebound looking likely over the coming twelve months. GDP growth, Huang says, is likely to slow from 9.1 per cent in 2011 to 8.1 per cent in 2012 — with softer external demand and weaker residential investment — and inflation is likely to ease from 5.5 per cent to 3.2 per cent, but the outlook for China remains robust. Consumption is likely to play a greater role as household expenditure continues upward, and both monetary and fiscal policy settings should be modestly expansionary.

If Huang is right, as he usually is, this outlook for the Chinese economy is good news for the region and a boost for global recovery. Shaving 1 per cent off Chinese growth through the year would leave a strong performance in China and modest adverse impact on China’s overseas partners.

The two big risks for China are deepening recession in the industrial world economy and a disorderly correction of the housing market at home. China is suffering from a range of proximate economic problems, which have prompted fears of a hard landing. There has been a rapid increase in the number of small and medium enterprises (SMEs) declaring bankruptcy. Private lending has been drying up in some areas. In the last half of 2011 house prices were on a downward trend, with potentially significant implications for investment growth and asset quality. And, with the collapse of the real estate market, local governments are inevitably in trouble. Local government investment vehicles, with total liabilities of at least 10.7 trillion yuan (US$1.7 trillion), are finding it difficult to repay loans on schedule. In addition, the recent expansion of shadow banking transactions has opened up risks for the financial system.

With this bundle of problems, why is Huang so confident China will pull through the year so strongly? He cites three main reasons for why they are unlikely to lead to a hard landing of the Chinese economy.

First, the changes under way have been deliberately induced by policy adjustment, such as macro-policy tightening and housing investment restrictions. Some changes, such as the correction of property prices, were necessary to generate healthy development in the future. Should circumstances deteriorate sharply, the government will be able to reverse the policies quickly and buttress economic growth.

Second, these problems are not developing into systemic macro risks at this stage. Despite an increasing incidence of bankruptcy, the SME sector (read the private sector) as a whole is still underwriting steady growth. The widely reported collapse of private lending activities is isolated to particular regions, confined largely to a couple of cities in Zhejiang and Inner Mongolia.

And finally, balance sheets are still quite healthy for households, banks and the government — all of which should remain resilient even if the economic situation deteriorates. Total household borrowing is below 18 per cent of GDP, less than the value of households’ annual savings. If property prices decline modestly, households will not be forced to deleverage. And given the banks’ average non-performing loan ratio is low, at 2 per cent, and the reserve requirement ratio (RRR) is 21 per cent, some deterioration of credit quality is unlikely to make the banks dysfunctional in the near future. Public debt is only 17 per cent of GDP in China. If all contingent liabilities are included, that figure could blow out to nearly 70 per cent of GDP, but the government still has room to use fiscal resources to contain domestic risks and support economic growth.

The good news for the international economy is that the structure of Chinese growth through the new year will see gradual re-balancing toward the domestic economy. That will help relieve some of the global adjustment pressures. The sluggish external economic environment will see export and import growth likely halve to 9.8 per cent and 12.8 per cent, respectively, and a fall in net exports, accounting for almost half of the 1 percentage point drop in GDP. Despite the uncertainty surrounding housing, ‘residential investment should continue to grow in 2012 — albeit at a slower pace — due to large development projects, ongoing construction and the expansion of public housing’.

Consumption, Huang argues, will in fact be the key to maintaining the strength of the Chinese economy in 2012, although the pace of its expansion may moderate. ‘In recent years’, he points out, ‘retail sales have consistently outperformed GDP. But the GDP-by-expenditure data continuously show declining consumption, due to reporting errors in household survey data, such as the under-reporting of income and household spending. Estimates combining information from both GDP by expenditure and retail sales suggest a turning point in 2007, after which consumption’s share of GDP actually picked up steadily’. This is consistent with improvements in the Chinese social welfare system and the rapid growth that has been taking place in wage income.

All this suggests a good Chinese new year is in the offing.

And a note from the editors

The East Asia Forum continued to expand its reach in 2011. We moved to a new website and twice found we had to upgrade our server throughout the year due to increased traffic. Our hits more than doubled from 2010 and weekly email subscriptions grew by 20 per cent. We also saw rapid growth in our Facebook and Twitter presence and have started a Google+ page.

Most importantly, we have had great contributions.

The great contributions from around the region are what make EAF. It is a site owned by its contributors — a regional resource produced by analysts throughout Asia and the Pacific.

Our top most-read posts in 2011 (*some from 2010 and 2009) deserve highlighting.

1. 2011 East Asia Summit: New members, challenges and opportunities, Monica Wihardja, CSIS Jakarta
2. Japan’s earthquake and its economic impact, Peter Drysdale, ANU
3. Riding the global economic crisis in Singapore, Shandre, NUS, Singapore
4. Reforming housing for the poor in the Philippines, Marife Ballesteros, PIDS
5. The Philippines: Weak institutions drag on economic performance, Josef T. Yap, PIDS
6. The RMB and Chinese exchange rate policy: some misperceptions, Yiping Huang, Peking University and ANU
7. The impact of China’s 12th Five Year Plan, Yongsheng Zhang, DRC
8. China’s response to the global financial crisis, Yu Yongding, CASS, Beijing
9. The scale of China’s economic impact, Ligang Song, ANU
10. Vietnam’s endless corruption campaign, Long S. Le, University of Houston
11. Indonesia: Blessed by strong economic growth and the curse of resources, Thee Kian Wie, LIPI, Jakarta
12. Financial crisis: Can Asia skate through again?, Barry Eichengreen, UC Berkeley
13. Here we go again: Vietnam’s spiral of credit and devaluation, David Dapice, Harvard University
14. China’s role in running the world economy, Peter Drysdale, ANU
15. China’s rising sex ratio at birth, Zhongwei Zhao, ANU, and Wei Chen, People’s University of China
16. China’s export-led growth model, Yang Yao, Peking University

We value your feedback and wish all our readers and contributors the very best for 2012.

Peter Drysdale and Shiro Armstrong

Editors

East Asia Forum

1. Chinese economic risks
2. Five predictions for the Chinese economy in 2010
3. Thailand in 2011: a year of surprises

The present and future quality of Malaysia’s human capital is of considerable concern for the country’s policy makers.

Human capital is not improving as it should, and it threatens to constrain Malaysia’s growth objectives.

The Second Industrial Master Plan (IMP2) discusses at length moving up the value chain. This can have various meanings, but it must involve sophistication in production processes and an accompanying improvement in management methods.

The IMP2 covered the period 1996 to 2005. But the need for a skilled workforce is more pronounced now than it was 15 years ago when the IMP2 was drafted. This is especially true since multinational corporations can choose from a variety of locations within the region, like China, India and Vietnam. But even discounting the need to attract FDI by offering skilled labour, the development plans charted for Malaysia require high-quality workers.

The New Economic Model (NEM) for Malaysia (Part 1) unequivocally admits the country has a human capital deficit.

The NEM observes that Malaysia’s weak productivity growth ‘highlights the stark reality that Malaysia still lacks the sort of creativity and innovation that result in technological and technical progress’. Nothing can be more telling than to have a sub-section heading in the NEM Report which reads: ‘We are not developing talent and what we do have is leaving’.

However, the Tenth Malaysia Plan 2011–15 (10MP) was launched on the premise that Malaysia has an adequate supply of skilled labour.

The 10MP forwards ‘ten big ideas’ to move Malaysia into the high-income category, and two of these ideas are particularly pertinent to high-quality human capital. The 10MP also mentions ‘developing and retaining a first-world talent base’ as one of its five key thrusts.

In addition, the 10MP is supposed to focus on 12 national key economic areas (NKEAs), some of which are heavily dependent on the availability of skilled labour. Of these areas, financial services, information and communications technology, education, electrical products and electronics, business services, private healthcare, and greater Kuala Lumpur are the NKEAs that require a strong skilled labour force to achieve the targeted objectives.

For example, the ‘greater Kuala Lumpur’ NKEA is meant to transform KL into a world-class city and international financial district. But without skilled workers with international exposure — from top-level management supported by competent middle-level managers and, lower down, skilled officers — it will not be possible to have an international financial district.

Similarly, the indicators regarding the level of science and technology in Malaysia do not portray an encouraging picture.

Malaysia’s research and development expenditure, as a percentage of GDP, stands at 0.6 per cent. This lags behind Singapore’s expenditure of 2.3 per cent, South Korea’s 3 per cent and Japan’s 3.4 per cent. And while Malaysia had about 531 patent applications in 2006, Korea had 125,476 and Japan over 300,000. The number of journal publications is equally unimpressive: Malaysia had 808 published articles in 2007, eclipsed by Singapore’s 3792 and Japan’s 52,895.

But despite the Malaysian government’s concerns, surprisingly, very little is being done to rectify human capital issues.

Plans like the 10MP speak as if nothing is wrong. They are being drawn up on the assumption that skilled workers are readily available: the areas specified for moving up the value chain are those dependent on high-quality labour.

On top of all this, there are complaints that fundamental education reforms have diluted the spirit of nationalism and the rights of the majority.

Until 1976, English was the medium of instruction in Malaysia’s schools and universities. This was subsequently changed to Bahasa Malaysia, and remained so until 2002 when then-Prime Minister Mahathir Mohamad directed that science and mathematics be taught in English, with the medium of instruction otherwise remaining in Bahasa Malaysia. The reason for this sudden shift was so Malaysians could be better equipped to keep abreast of developments in science and technology, making Malaysia more globally competitive.

But now there are emotional suggestions that the teaching of science and mathematics should revert to Bahasa Malaysia. The arguments for this reversion are justified in a number of ways, primarily by appealing to nationalistic feelings and the imagined threat of the erosion of the Malay identity. Nevertheless, there is widespread acceptance that the general level of competence in English is declining. People ranging from industry leaders to former ambassadors are bemoaning this phenomenon. Again, the resulting implications for the development of human capital are not good.

A labour force that is educated, creative and innovative is the foundation for economic growth. Unless education reforms, including the teaching of science and technology in schools, are approached in a realistic and far-sighted fashion, it may be difficult to achieve substantial changes.

Shankaran Nambiar is an economist who consults for national and international agencies.  A version of this article first appeared in the Edge Financial Daily.

1. Can Malaysia graduate?
2. The ASEAN-China FTA: driving competitiveness in Malaysia
3. Imagining a new human rights strategy for Burma

At the moment of his accession to power, Kim Jong-il inherited the devastating impact of the collapse of the Soviet Union, the subsequent trade shock to North Korea’s economic output, the onset of the worst famine in modern history, and a humanitarian crisis that required a direct appeal to the outside world for help.

By the late 1990’s, he was forced to accept the realities of dependence on international aid, the rise of farmers markets as a grassroots response to the famine, and the introduction of capitalist notions such as ‘profits’ in the Constitution itself. Kim even briefly entertained the notion of establishing relationships with the International Monetary Fund, World Bank, and Asian Development Bank, attracted by the prospects for international finance, but balking at requirements for transparency, conditionality, and rules-based relations. Throughout his leadership tenure he only half-heartedly and grudgingly accepted the growing role for markets in the North’s economy and maintained a deep ambivalence to the prospect of economic empowerment of the North Korean people. His desire to maintain highly-centralised control over all aspects of North Korean society was sharply at odds with the decentralisation of information and decision-making needed for a market economy to replace a failed socialist economic management system. As a result, economic policy in the Kim Jong-il era was more shaped by events and forces for change than used as a tool to guide a managed process for national development.

Experiments in economic reforms were not accompanied by policies or the institution-building that would have been needed for recreating the economic success stories of China and Vietnam. Rather, the guiding light of economic policy for Kim Jong-il was mobilising resources for his purse from both domestic and foreign sources.  He was quite creative in devising ways to achieve this, such as demands for ‘loyalty’ payments, structuring of foreign exchange earning activities to send the cash to the top, negotiating with foreigners to get goodies for concessions, and pursuing illegal and internationally-sanctioned revenue-raising ventures.  At the end of the day, the North Korean economy under Kim Jong-il remains highly vulnerable to shortages of food, energy, and foreign exchange, with pressures for transformation of the economic system coming from both internal and external dynamics of change at work in North Korea.

Looking ahead, the key question is not whether there will be changes in economic policy but whether changes will be in the direction of building a market economy or governed by a new dynamic of competition for resources among contending parties for power.  The more the new regime leans towards the Worker’s Party, the more likely it will follow Chinese supported policies of developing a market economy under the guidance of the Party and gradually shift to funding defence needs from a centralised budget rather than the military having its own economic organs such as trading companies and banks that service them. The more the regime tilts towards the military, the more likely that competition for resources will trump incentives for pursuing systemic change.

While there may be an inclination to perpetuate the patronage practices of the elites by the Kim family, it is not likely that loyalties will transfer simply to the new leadership through such patronage alone. New incentives for supporting the regime will need to be pursued.  Key metrics of such changes will be in: 1) the ownership and transferability rights of assets; 2) the restructuring of the financial system including banking supervision, monetary-management policies, and development of the tax system and public expenditure policies to accommodate a market economy; 3) the support for decentralisation of economic decision-making and empowerment of traders and entrepreneurs; 4) the willingness to follow rules-based international practices in commerce and finance; and 5) the legal reforms to protect rights of parties in a market economy. This is a tall order, but one that might lead to a new dawn for North Korea.

Bradley O. Babson is a consultant on Asian affairs with a focus on Korea and Northeast Asia economic cooperation. He is retired from a career at the World Bank, with a concentration in East Asia. In the early 1990s he worked on the opening up of Vietnam and was the first World Bank Resident Representative in Hanoi.

This article first appeared here in 38 North.

1. Kim Jong Il’s death: continuity plus opportunity to engage
2. Kim Jong-il dead: apocalypse now or a new dawn?
3. Kim Jong-nam and the question of North Korea’s leadership stability

The dramatic increase in recent years of trade and foreign direct investment (FDI) in sub-Saharan Africa by firms from Asia — notably China and India — has become an emotionally charged and controversial issue.

For China, as Luke Hurst has written, Africa would seem an excellent complement to its resource- and market-seeking global agenda. Since 2000, China–Africa trade has grown at an average annual rate of 33.5 per cent. Although still second to the United States (whose trade with Africa amounted to US$140 billion in 2008), trade rose from US$55 billion in 2006 to around US$107 billion in 2008, accounting for 4.5 per cent of China’s total trade and surpassing the US$100 billion trade target set for 2010 at the 2006 Forum on China–Africa Cooperation (FOCAC). Trade is supported by modest yet rapidly expanding levels of direct investment, which reportedly jumped by 77 per cent in the first nine months of 2009, compared with the same period in 2008.

Most observers, says Harry Broadman, believe that Chinese (and to a lesser extent Indian) firms dominate Africa’s economies. This does not fit the facts. ‘About 90 per cent of the stock of FDI in Africa still originates from Europe and North America. FDI inflows from China have grown rapidly in recent years but the stock of capital from elsewhere is large. Nor are Chinese investors in Africa exclusively involved in natural resources’. Chinese and other investors from developing countries in Africa are increasing their investments in other sectors, such as telecommunications, financial services, food processing, manufacturing, infrastructure, back-office services and tourism. Natural resource-based investments dominate Chinese and Indian investors’ portfolios in Africa in value, Broadman points out, but the number of FDI projects by these MNEs is diversifying rapidly across many sectors.

As Deborah Brautigam points out in this week’s lead essay, Chinese development aid in Africa is also unusual in that much of the financial assistance provided does not constitute official development aid (ODA), but brings with it a focus on economic development opportunities. Much of it comes in the form of export credits and strategic lines of credit to Chinese-related companies, among other mechanisms. ‘In this sense’, she says, ‘it is very similar to Japanese financial flows to China several decades ago, when Japan began its outward march with a large line of credit to China, which, at the time, was not credit-worthy either. Looking at the nature of Chinese development aid — and non-aid — to Africa provides insights into China’s strategic approach to outward investment and economic diplomacy, even if exact figures and strategies are not easily ascertained’.

‘According to the Chinese white paper on aid released in April this year, approximately 40 per cent of China’s aid is financed through grants. Zero-interest loans are also a mainstay of China’s aid. The debt-relief program launched by Beijing in 2000 targeted overdue zero-interest loans for cancellation, with RMB25.58 billion worth (US$3.76 billion) cancelled, and of this, RMB18.96 billion (US$2.79 billion) was cancelled in Africa’.

‘Only large projects with a value of at least US$2.4 million, and that make a minimum 50 per cent use of Chinese goods and services, may be funded with concessional loans. China’s concessional loan program in Africa has grown rapidly. At the end of 2005, China Export-Import Bank had cumulatively funded only about US$800 million in concessionary loans in Africa, for 55 projects. Two years later, the number of African projects had risen to 87, and the cumulative value was about US$1.5 billion. And the government recently pledged US$10 billion in concessional/preferential credits for Africa, to be committed by 2012′.

The business-driven model of development that China now brings to Africa provides new opportunities to several African nations long overlooked — for being too high risk — as trading and investment partners. African countries and the African Union will need coherent, long-term strategies to apply leverage to international commercial interests and to create opportunities for enduring economic competitiveness and growth. But much is at stake for the 800 million people in sub-Saharan Africa, especially the 50 per cent of them who are among the world’s poorest, in the policy debate surrounding the continent’s accelerated integration into the world economy that is now prominently led by China and India.

Peter Drysdale is Editor of the East Asia Forum.

1. China and Africa: friends with benefits
2. Chinese development finance in Africa
3. India’s economic engagement with Africa

Chinese development finance in Africa is unusual in that much of the financial flows from China do not constitute official development aid (ODA). 

Instead, much of it comes in the form of export credits and strategic lines of credit to Chinese-related companies, among other mechanisms. In this sense, it is very similar to Japanese financial flows to China several decades ago, when Japan began its outward march with a large line of credit to China, which, at the time, was not credit-worthy either. Looking at the nature of Chinese development aid — and non-aid — to Africa provides insights into China’s strategic approach to outward investment and economic diplomacy, even if exact figures and strategies are not easily ascertained.

Chinese development finance in Africa involves two distinct types of financial flow: ODA and ‘other official flows’ (OOF). ODA as defined by the OECD refers to concessionary funding given to developing countries and multilateral institutions primarily for the purpose of promoting welfare and economic development in the recipient country. Funding must be ‘concessional in character’ (i.e. involving government subsidies) and loans must have a grant element of at least 25 per cent, using a 10 per cent discount rate.

While only concessional loans and grants qualify as ODA, governments also offer other official flows: funds for the donor country’s firms to subsidise or guarantee their private investment in recipient countries, military aid and export credits. These funds are reported as OOF. This category includes loans that are not concessionary in character, and official bilateral transactions — whatever their grant element — that are primarily export-facilitating in purpose.

China provides the equivalent of ODA through three instruments: grants, zero-interest loans and concessional (you hui dai kuan, or fixed-rate, low-interest) loans. These instruments finance Chinese government scholarships for African students; Chinese medical teams; ‘turn-key’ construction of stadiums, government buildings, telecommunications networks and other infrastructure; technical assistance teams in agriculture and other sectors; short-term training programs; youth volunteers; and material aid (the export of Chinese goods).

Grants and zero-interest loans were the primary instruments of China’s ODA until 1995, when concessional loans were introduced. According to the Chinese white paper on aid released in April this year, approximately 40 per cent of China’s aid is financed through grants. Zero-interest loans are also a mainstay of China’s aid. The debt-relief program launched by Beijing in 2000 targeted overdue zero-interest loans for cancellation, with RMB25.58 billion worth (US$3.76 billion) cancelled, and of this, RMB18.96 billion (US$2.79 billion) was cancelled in Africa.

Only large projects with a value of at least US$2.4 million, and that make a minimum 50 per cent use of Chinese goods and services, may be funded with concessional loans. China’s concessional-loan program in Africa has grown rapidly. At the end of 2005, China Export-Import Bank had cumulatively funded only about US$800 million in concessional loans in Africa, for 55 projects. Two years later, the number of African projects had risen to 87, and the cumulative value was about US$1.5 billion. And the government recently pledged US$10 billion in concessional/preferential credits for Africa, to be committed by 2012.

China also supplies other official funds that do not qualify as ODA. Three categories of loans are relevant here: export buyers’ credits, including preferential buyers’ credits (you hui mai fan xin dai) and commercial-rate, export commodity-secured or ‘mutual-benefit’ credits (hu hui dai kuan); official loans at commercial rates; and strategic lines of credit to Chinese companies.

For Africa, the OOF category provided by OECD members has normally been well below the level of funds provided on ODA terms. But this is not the case for China. China’s government-provided finance to Africa falls primarily into the OOF category, rather than ODA. As noted above, China’s official finance in Africa consists of grants, zero-interest loans, debt relief and concessional loans (which would all qualify as ODA), as well as preferential export credits, market-rate export buyers’ credits and commercial loans from Chinese banks (none of which would qualify as ODA).

In Africa, as elsewhere, Chinese aid agreements seem to follow diplomatic ties. China’s ODA does not appear to be given in larger amounts to resource-rich countries, as can be seen in flows to Nigeria and the Democratic Republic of Congo. Grants and zero-interest loans are distributed fairly evenly around the continent, while concessional loans fit a country’s ability to pay, either because it is middle income or because it will finance an income-generating project.

China’s economic push to ‘go global’ is coordinated by many policy instruments, including development aid. In this way, China’s strategy resembles Japan’s outward march more than it resembles the experience of other OECD countries. Chinese banks have developed instruments they believe can link Africa’s riches — its natural resources — to its development. Because they regard these resources as a source of wealth, they generally do not offer mutual-benefit loans (hu hui dai kuan) at concessional rates. And to the Chinese, even resource-poor countries like Ethiopia — whose balance sheets might not look good — sometimes have untapped capacity to service a future debt, if borrowed funds go toward productive projects. It remains to be seen whether fears about the sustainability of this debt are borne out.

Deborah Brautigam is Professor at the School of International Service, American University, and Adjunct Professor at the Department of Comparative Politics, University of Bergen. Professor Brautigam’s research was presented at China Update 2011. The annual China Update conference is hosted by the China Economy Program, in collaboration with the East Asia Forum, at the ANU in July. This article is a digest of a Professor Brautigam’s chapter ‘Chinese Development Aid in Africa’, in Jane Golley and Ligang Song (eds.) Rising China: Global Challenges and Opportunities. This book is the latest publication in the China Update Book Series, launched at the China Update conference every year.

1. China lifts Africa’s development prospects
2. When BRIC becomes BRICS: The tightening relations between South Africa and China
3. India’s economic engagement with Africa