Two words sum up Southeast Asia’s economic success: industrialisation and trade. However, the pandemic and recent conflicts have altered the global trade landscape and political economy. Given this context, can the countries of the Association of Southeast Asian Nations (ASEAN), including Indonesia, accelerate their own development by following the same recipe? There is no simple answer to this question, of course. Southeast Asia, in my opinion, must maintain its industrialisation and trade strategy while making significant changes. This is due to several key factors.
First, conflict and the Covid-19 pandemic have exposed various supply chain vulnerabilities and raised concerns about globalisation. Dependence on other countries causes issues when vaccine nationalism, medical supply shortages, and production disruptions occur as a result of supply chain reliance. As we saw in Asia during the global financial crisis (GFC), countries that maintained or even increased their share of GDP from domestic demand were in a better position to withstand the global economic downturn. Indonesia, for example, survived the GFC thanks to appropriate policy responses because it was less integrated into the global economy than export-oriented economies such as Singapore or Taiwan. Thus, to some extent, we require the domestic market.
Second, digital disruption and the global turn towards a greater focus on protecting the environment have resulted in a shift in the pattern of industrialisation. Our industrialisation strategies can no longer afford to rely solely on the low-skilled manufacturing industry and the creation of low-skilled jobs. There is a need for improved human capital quality as well. We must not just create jobs, but good jobs.
Third, Southeast Asia cannot thrive if it looks inward. Due to limited domestic capacity, Southeast Asia cannot afford to take the path of autarky. Even if the region had the capacity, choosing an inward-looking approach may result in higher production costs. Reducing the reliance on foreign inputs increases the reliance on domestic inputs, which is counterproductive because any national pandemic-related lockdown affects domestic sectors; there is generally no resilience benefit from re-nationalising international supply chains. In the case of Indonesia, imports are an important part of encouraging investment, with raw materials making up 90 per cent of imported goods. In tandem, the positive lag effect of exports is driving the country’s strong household consumption. This means that trade will continue to play a vital role. Indonesia, which has a very large domestic market, cannot afford to be autarkic or disconnected from global supply chains, let alone other ASEAN countries with smaller domestic markets.
Fourth, it is getting harder to make good economic policy decisions. Political pressure to reduce economic interdependence is rising across the world. The reasons for this include an increased focus on national security, the emergence of identity politics as a result of weakening economic growth, and opportunities for rent-seekers to justify the need for protectionist policies. Consumers, on the other hand, continue to desire access to high-quality, low-cost goods and services. As a result, policies are likely to become more stringent. Southeast Asia’s economies have a history of growing regional and global economic integration. Many of the factors driving discontent with globalisation in rich economies do not exist to the same extent in Southeast Asian countries. Nonetheless, there is no room for complacency. Economic growth is slowing in some countries and economic insecurity persists.
So, what should be Southeast Asia’s future development strategy? Southeast Asia, I believe, should remain connected to global supply chains with some important modifications.
First, it is critical to maintain domestic demand. However, given the importance of trade to economic growth, improving domestic economic integration can help boost demand while also improving export competitiveness. Domestic transaction costs can be reduced by investing in both physical and soft infrastructure.
Second, all countries, including those in Southeast Asia, must diversify their supply chain bases; diverse exports and destinations are required.
Third, digital technology will play an increasingly critical role. The spread of automation and the rapid adoption of other technologies such as video conferencing and e-commerce have helped reduce the economic disruptions caused by the pandemic. We will also see the manufacturing sector shift from just-in-time production to a focus on safety stock intermediate inventory.
Last, in terms of employment, the continuing expansion of Southeast Asia’s middle class will drive growing demand for higher-skilled workers. This requires a jumpstart in the quality of training and education. If governments can improve their skills base, they can precipitate a virtuous circle that will further boost the size of the middle class and accelerate the shift away from low-skill, low-wage jobs.
In the future, Southeast Asia cannot rely solely on natural resources or low-wage labour, as it has too often in the past. But significant economic change will not happen overnight, for the reasons I set out above. The key questions are how quickly and smoothly Southeast Asian governments can manage the adjustment and fund its costs. There is room for industrial policy, so long as it leads to higher research and development spending, and investment in human capital and infrastructure, rather than providing cover for protectionist policies. What Southeast Asia needs is not a change in development strategy, but to refine its development strategy. Trade and industrialisation remain the keys, adapted to meet the challenges of a region and a world under strain.
How can barriers to further liberalisation be overcome?
Several factors make it difficult for various countries to continue liberalising. First, there are changes in global geopolitics and slowing growth in the global economy. In recent years, there has been an increase in economic nationalism, which has been triggered by a variety of factors, most notably rising inequality, particularly in developed countries. The preceding developments demonstrate that the first-generation model of globalisation, which entailed erecting the lowest possible barriers to trade in goods and services, did not garner widespread political support. So far, the assumption that economic reform through market opening will be followed by political reform has not been realised. Globalisation’s positive impact on people is not being felt. As a result, political support for globalisation has dwindled, and resistance to globalisation has emerged.
Second, we are beginning to see signs of a shift in the economy’s structure, which previously relied on the manufacturing sector but is now moving towards the service sector. This is also a symptom of China’s adjustment process. As economist Dani Rodrik of Harvard University stated, unlike manufacturing, the service sector necessitates much higher levels of education and training. As a result, the service sector is not a perfect replacement for manufactured exports. Outside of tourism or simple services, the sector also generally necessitates strong institutions. And this is the main weakness of emerging market countries: human and institutional capital. This has the potential to encourage increased protectionism in developing countries.
What steps can be taken under these conditions to ensure the viability of the global trading system? From a political economy standpoint, I believe that, while ideal, unilateral reform is difficult to implement. Economic nationalism and supply chain disruption are the main hurdles. Continuing multilateral cooperation, on the other hand, is an optimal solution. However, the facts show that progress in multilateral cooperation is extremely slow, and deadlocks are possible. Regional cooperation is another option, while still attempting to combine unilateral reform with a multilateral framework. In this context, open regionalism is the second-best form of regional cooperation available.
Of course, a combination of the three approaches is also an option. Creating several successful stories is critical in terms of the political economy of reform. The dilemma of reform is that the cost is always immediate, but the benefit is long term. As a result, in order to gain political backing, it is necessary to achieve quick victories. Reforms that only address long-term issues without considering the political cycle will face difficulty gaining support from politicians and leaders. It is necessary to have modalities in place that allow for multi-stage regional cooperation, beginning with less ambition and gradually increasing in complexity.
Has governance become a binding constraint for the region?
Former Venezuelan minister of Trade and Industry Moisés Naím divides reform into two categories: the first generation of reforms, which includes macroeconomic stabilisation, tariff reduction, budget cuts, and privatisation; and the second generation of reforms, which are broader in scope and include bureaucratic reform, efforts to improve public services, and the maintenance of human capital quality. According to Naím, while the first generation of reforms discusses the instruments to be used, the second generation focuses on desired outcomes, such as improved public services. Because it is closely related to change or institutional development, the second generation of reforms is likely to be more complex and difficult to implement and come with a lower chance of success.
With conditions such as the current pandemic, the role of the second generation of reformers is becoming more important because the government is expected to be responsive, make quick decisions, and provide good public services. This process is not always easy in a vibrant democratic system. Decision speed, for example, is difficult to achieve because it necessitates the cooperation of multiple parties. With the limitations of existing bureaucratic capacity, the role of technology and collaboration with the private sector, non-governmental organisations, and the community becomes critical.