Diversification, not specialisation

Yuen Yuen Ang is Professor of Politics at the University of Michigan. She was named by Apolitical as one of the 100 Most Influential Academics in Government.

As a rising global power, China has been eager to share lessons from its development success around the world — and the most obvious of those, it seems, is on export manufacturing. Justin Yifu Lin, former chief economist at the World Bank and an influential policy advisor in China, urges developing countries to “follow the tried and tested path to prosperity”. They should leverage their comparative advantage in labour-intensive, low-wage manufacturing (e.g., garments and toys) and then gradually move up the global value chain. Furthermore, he adds, they should build export zones and industrial parks like those in China.

There is no doubt that export manufacturing will remain a key growth driver among developing countries given its potential to generate mass employment for the rural population who can send wages home, urbanise, and eventually enter the ranks of middle-class consumers. But times have changed since the peak growth period in East Asia. In Southeast Asia today, specialising in export industrialisation alone will not be enough and will render such economies vulnerable to external shocks. Diversification is now the zeitgeist.

The current developmental state model grew out of a particular combination of global factors. The “long peace” in the seven decades after the Second World War centred on a US-led global order. (Although in certain parts of Asia, such as Vietnam, the Cold War boiled over into devastating conflict.) To draw and build on alliances during this period, the United States spearheaded a liberalisation of the world economy. Newly industrialised economies could benefit from open market access in developed economies while protecting their own industries. The fall of the Soviet Union in 1991 and the creation of the World Trade Organization (WTO) in 1995 further expanded global trade. China grew explosively after it joined the WTO in 2001.

The twentieth-century global order has today been upended in several ways. First, developed economies have gone from championing globalisation to resisting it. In the United States, the Trump administration promised to bring manufacturing jobs home under the banner of “America First”. Although President Joe Biden has reversed many of his predecessor’s policies, he maintains the same course on trade protectionism. This wave of de-globalisation has been exacerbated by the pandemic and geopolitical tensions between the United States and China. A “decoupling” of the superpowers may transfer some manufacturing from China to Southeast Asia, but it also brings unpredictability for countries that trade extensively with the two giants.

Second, the effects of climate change and ecological crises are becoming more critical by the year. Southeast Asia is especially susceptible to rising sea levels and widespread flooding. There is no point building sprawling industrial parks if parts of Ho Chi Minh City and Bangkok will be under water in the coming decades. Indeed, Indonesia has announced plans to move its capital from the sinking metropolis of Jakarta. Whereas “green” development used to be a goal that countries strove for once they reached a sufficient level of wealth, developing countries today must prioritise sustainability and decarbonisation now. As we have learned from China’s ongoing energy crunch, balancing growth with carbon emissions reduction is not easy.

Third, technological disruptions are bringing a mixture of peril and promise to Southeast Asia. On the one hand, automation threatens to eliminate numerous labour-intensive manufacturing jobs. On the other hand, the increased use of the internet and mobile phones — spurred by lockdowns during the pandemic — has spawned new businesses and industries, from e-commerce and ride-hailing apps to fintech and edtech. This provides unprecedented opportunities for Southeast Asian countries to partially leapfrog past manufacturing and into a range of technology-enabled services. Kevin Aluwi, the CEO of Gojek, an Indonesia-based technology company, declared in 2021, “We’re about to enter the golden age of technology companies in Indonesia and the rest of Southeast Asia.”

All of these ongoing disruptions compel a drastic rethinking of national development strategies in Southeast Asia. Economic specialisation is being replaced by diversification. Furthermore, climate change mitigation and technology must be at the heart of any development plan.

Working with the United Nations Development Programme, I saw these shifts in action in Cambodia. In 2018, the government of Cambodia unveiled the “Rectangular Strategy” — a four-pronged development vision for 2050. One of the pillars is economic diversification, which includes developing new sources of growth, promoting banking and finance, preparing for the digital economy and fourth industrial revolution, and improving the logistics system. According to the report, the Cambodian economy needs to diversify in order to be “resilient to shocks”. Policymakers also recognised that as Cambodia graduates from least developed country (LDC) status, it will no longer enjoy the trade benefits that it used to have.

But while there is a well-trodden path in export manufacturing and abundant experience in designing industrial policies for economic specialisation, there is no established playbook for diversification. What should diversification entail? What is the right mix of sectors and services in a diversified economy? What can governments do to support diversification? How can developing countries simultaneously conserve the environment and produce growth while they are not yet rich?

These are new challenges and questions for which there are no easy or clear solutions. The scholarly literature has not yet noticed, let alone responded to, these disruptions. Stephan Haggard’s primer, Developmental States, for example, does not once mention “economic diversification” as a national strategy, or the words “digital” or “climate change”.

The first step of adaptation is to recognise that conditions have changed. The modern world is in a new chapter of “development”, with new priorities, dilemmas, dangers, and opportunities. We must change the questions we ask before we can find the right answers.

Challenge questions

What role should industrial policy play in Southeast Asia in meeting these new challenges?

Industrial policy is a term that is often debated but seldom defined. Specifically, it means government policies to support selected industries that are considered strategically important. On industrial policy, there is no one-size-fits-all answer for Southeast Asia, which includes countries with very different socio-economic conditions and economic activities. Diversification and building climate resilience do not amount to an “industrial policy”, as I understand it. These should be considered part of an overarching national paradigm that defines the goals and priorities of development. This may involve selecting industries as a policy tool.

The basic formula for export-led manufacturing does not differ significantly around the world. It includes focusing on areas of competitive advantage (e.g., wage-intensive, low-cost manufacturing) and having governments who promote industrialisation by providing political stability, low-wage labour, and infrastructure.

As Joseph Wong argues in his book, Betting on Biotech, this model reaches its limits when governments attempt to promote uncertain industries, such as biotech, because they cannot predict success accurately and plan ahead. Technocracies will always be indispensable for reliable policy implementation, but dealing with uncertainty (climate change) and multifaceted social problems (inequality) are qualitatively different tasks. I would argue that Deng Xiaoping’s “directed improvisation” system would be a suitable model for this new environment because it relies on the government to direct rather than plan and dictate, while encouraging local actors to discover indigenous solutions to local problems. I introduce this model in depth in How China Escaped the Poverty Trap.

Should Southeast Asia follow China in emphasising higher quality growth and common prosperity?

In principle, of course! One of the United Nations’ Sustainable Development Goals (SDG) is “inclusive growth”, which President Xi Jinping’s leadership calls “common prosperity”. The challenge is how to achieve high-quality, inclusive growth at early stages of development, when income is low, capacity is weak, and there are not enough resources to go around. For instance, many low-income countries rely on low-wage manufacturing and ignore environmental and labour regulations in order to gain a competitive edge. If they follow standards of high-quality growth, their model — which countries in East Asia and China have pursued to achieve rapid industrialisation — will be unacceptable. By contrast, Bhutan is a poor country, but it has equality and pristine ecology; normatively, the country is willing to accept low growth for the non-financial benefits that its policies bring. To be clear, I am not saying that Southeast Asia should give up on inclusive growth. I am saying we need to be realistic and recognise the trade-offs and hard choices that governments must make, otherwise “inclusive growth” will just be a slogan.

Yuen Yuen Ang is Professor of Politics at the University of Michigan. She was named by Apolitical as one of the 100 Most Influential Academics in Government.