Long road to resilient development – The Phnom Penh Post

The World Bank recently released a report entitled Resilient Development: A Strategy to Diversify Cambodias Growth Model as the latest Cambodia Country Economic Memorandum.

The report revisits Cambodias growth model, with the objective of identifying constraints and opportunities for sustained economic growth and proposing policy options to address them.

Claire H Hollweg, a senior country economist for Cambodia at the Washington-based multilateral lender, sat down with The Posts May Kunmakara to discuss the Kingdoms economic performance in 2020, export diversification and skills development themes touched on in the recent report.

The report mentions that Cambodias growth slowdown in 2020 in the wake of the Covid-19 pandemic was among the most pronounced in the East Asia region. What brought about such an enormous impact on the Kingdoms economy?

The report shows that Cambodias economic slowdown lies in the countrys growth generating process. Cambodias growth has been remarkable, but insufficiently diversified in products, markets, and factor inputs.

Five products garments, footwear, rice, cassava and tourism accounted for 80 per cent of total exports; two markets the EU and US accounted for 69 per cent of merchandise exports; and foreign capital through foreign direct investment (FDI) and official development assistance (ODA) accounted for 72 per cent of gross fixed capital formation in 2018.

Not surprisingly, when the pandemic disrupted the cross-border flow of goods, services and capital, Cambodia was ill-positioned to absorb the shock.

Youve talked about the countrys inability to diversify its development. Can you explain more?

Cambodias inability to diversify its development through alternate products, markets and financing sources predates the pandemic, and has its roots in low and declining productivity, low quality and weak export linkages, and high FDI but low domestic investment. The Covid-19 crisis exacerbates these challenges.

The first component is low and declining productivity: Cambodias inability to grow the product basket is explained by low labour productivity, or output per worker, which lags behind most countries globally when at Cambodias development level.

Low labour productivity, at least in part, reflects low human capital. But the largest contributor is low and declining total factor productivity (TFP).

This reports analysis suggests two primary causes. First, resource misallocation within sectors, likely caused by shortcomings of market institutions where market signals governing resource allocation need to be generated in more competitive and well-regulated markets, and an incipient public investment management (PIM) system where greater value for money in domestic public investment is needed.

Second, and more important, low within-firm productivity growth, explained by a challenging business environment that imposes significant obstacles to firms operations. Poor access to finance, inefficient business regulations, prevalent informality, and inadequate electricity are found to be the main constraints to firm productivity performance in Cambodia.

The second component is low quality and weak export linkages: low competitiveness and limited integration within global value chains (GVCs) have led to concentrated markets and trade.

A primary cause of low diversification and inability to upgrade is the quality of FDI, where FDI firms do not create backward linkages or share knowledge, limiting opportunities for technology transfer and productivity spillovers.Barriers in the business environment and the current investment and tax incentives regime influence the quality of FDI.

Other constraints to diversifying and upgrading Cambodias trade are low firm and worker capability, costly trade-related regulatory barriers particularly affecting agricultural products, insufficient trade-related infrastructure, and nascent use of regional trade agreements to support greater market access for exporters.

The third component is high FDI but low domestic investment: the countrys low private savings rate, and as a result low domestic investment, has led to reliance on external financing sources.

Rather than how many households save, how much households save and more important how households save appear to be key factors impeding greater domestic investment.

While 51 per cent of adults reportedly saved some money in the past year, only 22 per cent had any savings at a point in time, and only five per cent participated in formal savings where it can earn higher returns, be better protected, and, from an efficiency perspective, be intermediated to the most productive uses, significantly below other countries at Cambodias level of economic development.There is a relatively lower share of adults with a savings account in Cambodia.

Low formal savings by households stems from inefficiencies in the formal financial sector that pose high barriers including financial sector regulatory gaps, low financial literacy, low technology adoption and therefore limited access to financial services, and underdeveloped financial instruments beyond banks and microfinance institutions (MFIs) that would otherwise support savings.

What recommendations would you offer to diversify development?

Urgent action is needed to support Cambodias economic recovery from Covid-19 in a way that addresses the diversification problem to build back even stronger.

Cambodias policymakers have the opportunity to forge a new growth path by enabling productivity of firms and workers, diversifying exports, and harnessing domestic investment.

An ambitious reform agenda is needed one that focuses on improving capabilities, strengthening regulations, and investing in infrastructure.

Would you mind explaining each of these hypothetical growth paths?

A focus on firms and their workers is key to unleashing productivity. Policy reform in target areas can help the country meet its potential, including: investing in human capital through health and education; supporting more efficient resource allocation through improved market institutions and public investment management; easing the regulatory burden for firms thereby reducing informality and its negative impact; and improving the performance of key services inputs to strengthen domestic linkages.

Diversification of exports can continue driving growth during the recovery from Covid-19. A cross-cutting and medium-term policy agenda to diversify Cambodias trade is structured on upgrading in manufacturing global value chains, creating value addition in agriculture, and increasing competitiveness to export modern services.

Harnessing domestic investment can help finance the next phase of growth. Policy areas include promoting FDI into productive and export sectors; promoting higher domestic savings rates; improving financial inclusion through greater access to savings institutions; supporting digital access through digital technologies; lowering the costs of savings accounts; and supporting financial sector stability and development more broadly.

This interview has been edited for length and clarity.

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Long road to resilient development - The Phnom Penh Post