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Cambodia’s small economy means it will continue to be reliant on exports for economic growth, but needs to do a much better job diversifying its economic base and boosting production

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TRACEY SHELTON

Cambodia must sort out its infrastructure problems if it hopes to unlock growth potential.

Infrastructure spending means jobs now, and later

Previously a textbook example of how a country could export its way out of poverty, China is now showing the world how shifting to an investment- and infrastructure-heavy growth model can take up the slack from falling demand for exports. While Cambodia’s small economy means it is unlikely to shake a reliance on export markets, its relatively poorly developed infrastructure provides plenty of room for new investment. And it won’t be wasted. According to ANZ Royal CEO Stephen Higgins, high electricity costs are a major business constraint in Cambodia, costing 18 US cents or more per kilowatt-hour in Cambodia compared to just 5.4 cents in Vietnam.

Transport costs are also another obstacle, costing around $15 to move one tonne of agricultural produce 100 kilometres in Cambodia,

compared to less than $8 in Vietnam and less than $4 in Thailand. In part this is due to the country’s poor road network – just 5 percent of Cambodia’s roads are paved, compared to more than 20 percent of Vietnam’s and almost all of Thailand’s. The question of how to fund the investment required is a difficult one. Although the government has shown it is open to private investment in infrastructure, it is likely to have to do the bulk of the heavy lifting itself, say analysts. As Higgins points out – and as China has so capably demonstrated – government borrowing to invest in infrastructure provides a win-win opportunity. “Building infrastructure will create jobs now,” he said. “Actually having it will encourage business to set up here in the future and provide jobs on an ongoing basis.”

NATHAN GREEN

AS new data coming out around the world begin to point cautiously towards early signs of a global economic recovery, debate is intensifying about the merits of export-led development.

This month the International Monetary Fund (IMF) urged Asia to "rebalance" its growth model to reduce its reliance on exports and instead focus on boosting domestic demand. The call came as the fund slashed its growth outlook for Asia after the region's merchandise exports fell at an annualised rate of 70 percent between September 2008 and February this year, substantially worse than during the 1997-98 Asian financial crisis.

Although the fund noted that economies with a heavy reliance on high-tech exports had been hit hardest - it singled out Malaysia, the Philippines and Thailand as the most affected economies in Southeast Asia ­- Cambodia has not escaped unharmed.

In the wake of the global downturn, a decade of nearly 10-percent GDP growth per year has come screaming to a halt. Some international institutions have predicted a 2 percent contraction this year.

"It is apparent that the country's economic boom did not have a solid grounding, with the origins of growth being narrow and restricted to four sectors - garment exports, agriculture, real estate and construction, and tourism," Danny Richards, the Economist Intelligence Unit's (EIU) Cambodia analyst, said Thursday by email.

The most recent official figures available show garment, textile and footwear exports dropped almost 20 percent in the first two months of this year compared with 2008.

Tourism, another key export earner, was also hit hard. Figures from the Ministry of Tourism show arrivals fell 1.2 percent in the second half of 2008 after growing 12.6 percent over the first six months. Cambodia Association of Travel Agents President An Kim Eang told the Post last month that tourist arrivals dropped 6 percent in the first two months of 2009.

If Cambodia was to follow the IMF's advice and attempt to rebalance to get away from a reliance on export dollars, it would do well to look at China.

Previously a textbook example of how a country could export its way out of poverty, it has led the way since the crisis began by boosting domestic demand on the back of a $580 billion stimulus package announced in November.

But as Stephane Guimbert, the World Bank's chief economist for Cambodia, points out, Cambodia's small domestic economy will prevent it following China's lead. "In Thailand or China you can rethink your model because you can live on your domestic market, but we don't think it is a viable option for Cambodia," he said. "The model might be adjusted somewhat, but at the end of the day exports will remain key for Cambodia's growth in the future."

The model might be adjusted somewhat, but at the end of the day exports will remain key for Cambodia’s growth in the future.

Beyond garments

Stephen Higgins, CEO of ANZ Royal Bank, agreed that exports were the future but said Cambodia needed to develop an industrial policy to expand its manufacturing base beyond garments.

Over the last decade, manufacturing contribution to economic output in Cambodia has increased from 10 percent to around 30 percent today.

However, it still lags far behind neighbouring Vietnam and Thailand, where manufacturing accounts for between 40 and 45 percent of GDP. Worryingly, the garment sector accounts for 70 percent of Cambodia's manufacturing activities and exports, while food manufacturing accounts for just 10 percent, despite the country being at the centre of the Mekong Delta food bowl.

"Focusing on areas like the garment sector has been fantastic in building up Cambodia's economy, but it is very important for Cambodia to diversify and broaden its economic base," Higgins said. "Countries like Vietnam have used the sector to build up their economies, but as they have developed, they have broadened successfully into other manufacturing, especially light manufacturing."

Boosting manufacturing capacity would also reduce the country's reliance on imports, he added, further helping balance the economy.

Diversification will not be easy. A senior official within the Ministry of Commerce, who spoke only on condition of anonymity, said the government had recognised the need to diversify well before the economic crisis hit.

He said the end of the Multi-Fibre Arrangement in 2004, which limited garments from developing countries like China while benefitting the poorest countries, such as Cambodia, should have been a watershed moment for diversification. However, the sector proved resilient and no major changes to the country's economic structure were seen.

"The government had this idea years ago, but as a poor country it is hard for us," he said. "Even if we have good ideas, we need assistance from development partners to help us realise our goal."

Guimbert said the key to success was to diversify in stages. In the short-term, Cambodia needed to try to capture a larger share of existing value chains, such as by moving beyond the most basic cut-make-trim (CMT) stage of garment production, he said, adding that the country should also try to capture the value-added component of the agricultural sector by processing food rather than exporting it raw.

The key to diversification within sectors was coordination, both between businesses within a sector, and between business groups and the government, he said, pointing to the rapid growth of the garment sector as an example.

Governance arrangements between the government and the garment sector had removed many obstacles to growth, Guimbert noted, such as customs barriers. World Bank statistics showed that getting containers in and out of the country was much faster for the garment industry than for the agriculture sector or any other industry.

"The bottom line is that these sectors managed to get better governance arrangements and that generated growth," Guimbert said.

Diversification into new sectors was a longer term goal, he said. "These short-term improvements are within reach, but further diversification requires much more," he said, pinpointing infrastructure development, mobilisation of savings and capital, and workforce skills as central.

Invest in people

Susanna Coghlan, director of training at AAA Cambodia, an HR firm, said the educational system needed to prioritise vocational training over higher learning to better match skills to labour-market demands.

"Vocational training has the potential to make a big impact on the labour market in Cambodia and will become increasingly important as the Cambodian economy diversifies and expands," she said.

Provincial training centres were needed to boost skill levels outside of main centres and to provide a workforce for special economic zones being built around the country. Apprenticeship and internship programs were needed to boost on-the-job training, she added.

But Sandra D'Amico, managing director of HR firm HRINC Cambodia, said the development of a vocational training system was held back by the lack of a strategic vision for the workforce in Cambodia.

"Where are we going with our labour force?" she asked. "India decided it wanted to dominate in IT, and they have done a good job of developing that sector. But I don't think Cambodia yet has a vision."

Industry associations like the Garment Manufacturers Association of Cambodia and the Cambodian Hotel Association have worked independently with the education sector to develop training programs meeting their own specific needs, but a coordinated response to the skills and education challenge was necessary to diversify the country's economic base.

"It has to run through the entire education system so that everybody is moving towards one goal," D'Amico said.

But Richards doubted the government had its priorities in the right place when it came to education, pointing out that it planned to raise defence spending in its latest budget rather than spending more on education and health.

"Cambodia has a young and expanding population, and this could turn into a demographic liability if insufficient jobs are provided," he said.

Money needed

Ultimately, diversification and future growth boiled down to attracting investment, Richards said. The country had done a tremendous job of attracting foreign capital over the last few years, but stricter capital markets would make that more difficult over the next few years. meaning the country had to do a better job of mobilising domestic savings.  

"The present investment ratio in Cambodia is too low," he said. "Savings need to increase and more has to be channelled into productive investment."

To mobilise savings, Guimbert said the business environment had to be streamlined to raise the chance of success and provide incentives for investors to take risks. This could be done by making business entry easier, improving bureaucracy, opening up access to credit and - given the importance of exports - streamlining customs procedures.

"If all this happens, there is a sense that you could make much better use of existing savings," he said.

"We suspect a lot of people will be willing to invest in rice or crop processing if only they had the confidence that they would be able to export without unnecessarily high fees on the road or the border," he said.