Getting the fundamentals right

The more things change, the more they stay the same.

The Philippines and Indonesia have both delivered impressive data in the past few years: GDP growth exceeded 6 per cent in both countries in 2010, while stock markets in Manila and Jakarta over the past two years have both seen similar strong performances.

So do these headline-grabbing numbers represent a new promise in South-East Asia’s leading economies, emerging with a confidence not seen since the heady days of the early 1990s? The answer lies in the foundations underpinning these apparently strong figures.

In the Philippines this growth has been driven in no small part by the powerful emergence of the call centre business. By 2011, the country had replaced India as the global leader in call centres, with more than 600,000 Filipinos employed directly in the industry.

Indonesia’s surge meanwhile has been powered almost entirely by its booming resource based economy. Like with Canada and Australia, ravenous appetites from emerging economies such as China have driven demand for commodities such as coal and iron ore. And while that demand has tempered recently, the effects of the past few years are still reverberating through the Indonesian economy.

But economic growth predicated on the success of any one industry is a perilous endeavor at best.

Singapore’s policy makers learned this lesson a decade ago when its electronics industry, heavily dominated by foreign firms, came under threat from China. Asia’s emerging economies could learn another lesson from the Singaporean experience.

Guiding growth

ThinkAloud7Singapore, among all nations in Asia, has perhaps the most robust set of institutions to guide its economic growth. The emergence of efficient and effective institutions was no accident – it was a deliberate step taken by Singapore’s leaders since the country’s foundation in 1965. Today the political-regulatory framework in Singapore is replete with acronyms that define the city-state’s strong institutional environment – MOM, MOE, SPRING, EDB, MAS and MTI, to name a few.

A strong institutional environment is the necessary foundation for strong economic growth because it provides for stability and reasonable predictability in regulations, and confidence in transactions. Strong institutions help reduce corruption, forestall the development of undue regulation, protect property rights, provide for a sound legal system, and, via a strong education system, promote the development of a nation’s human capital.

The importance of institutions is not new, but it is one that is often overlooked, particularly when economic growth is strong. It is when economic growth begins to slow or even decline that their importance re-enters the public consciousness.

Take the cases of China and India. In the first decade of the 2000s, both nations experienced enviable levels of economic growth. The repeated years of near 10 per cent GDP growth in China overshadowed the fact that China’s development was not supported by vital fundamental changes to its institutions.

Clearly changes in the political system will not come voluntarily, yet it is reasonable to expect China’s leaders to address long-standing deficiencies in systemic corruption, poor intellectual property protection and inequities in the competitive environment.

jakarta280Indonesia’s economy has surged on the back of the resources boomWithout such changes, astute managers will question whether they should site investments at the core of a company’s competitive advantage – such as leading research and development or other high value-added activities – in China.

Meanwhile in India, the story bears strong similarities to what we now see in the Philippines. Remarkable development in the outsourcing industry as supported by the country’s leadership in developing engineers helped promote fabulous growth in India. Yet that growth was not accompanied by much-needed developments in infrastructure, such as seen in China that would have permitted manufacturing industries to develop.

Consequently, India has become an economy dominated by agriculture and services. Moreover, longstanding public sentiment against capitalism, as rooted in the pre-1991 economy, further hindered good growth in the private sector.

Institutional deficiencies

As a result China and India are today facing the challenges of institutional deficiencies and overcoming entrenched societal and political interests. How the countries fare in the next decade will in no small part depend on how political and business leaders address these challenges.

site280Growth may look impressive, but what really has changed?The same lessons extend to the Philippines and Indonesia. The Philippines has benefitted from the identical source of growth that India had a decade ago. It also benefits from a continued expansion of its overseas population and the consequent surge of foreign remittances.

But a two-pronged growth strategy is several prongs short of stability, particularly when the prongs are embedded in a weak institutional environment. Ineffective and corrupt government, poor education and social liberation are just three important areas that need attention for the Philippines to see its growth extend beyond the short term.

In Indonesia, the obstacles are different, but the implications are the same. The country has gained tremendously from the resources boom. Further, the decentralisation of the regulatory environment from the central government to provincial and other local authorities has helped stabilise regulations for mining and foreign investment.

Yet substantial uncertainty still resides on these regulations, hampering projections about the future stability and predictability of revenue flows from such investments. Given the long-term nature and irreversibility of mining operations, investments will not be made unless there is confidence in both the regulations and regulators.

Looking at the Philippines, Indonesia or other economies in Asia, we can marvel at their economic growth, but at the same time we must ask, ‘What has changed?’

If the foundation has not changed, such growth will be temporary and inevitably stop with a hard, uncomfortable landing.

Most Asian economies have proven to be resolute and effective in bouncing back from crises. They have recovered very well from their debt positions of the Asian Financial Crisis in the late 1990s.

But the challenge remains for political and business leaders to address issues in their institutional environment to bolster political systems, tighten legal systems, improve corporate governance, protect property rights, protect minority shareholders and help separate state and business interests.

Only then can they follow the likes of Hong Kong and Singapore and move into the upper echelon of world economies.

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