As Driver of World Economic Growth, Asia’s Vulnerabilities Emerge

January 7, 2015

By Véronique Salze-Lozac’h, Amy Warren, Nicolas Picard, and Ka Wai Wong

2014 will be remembered as the year when China became the world’s biggest economy in purchasing power parity (PPP) terms, overtaking the United States for the first time in history. This move, which did not come as a surprise, is the sign of a superpower transition and further evidence of the rising role of Asia on the international stage in what some already call the “Asian Century.”

In 2015, Asia will continue to be the driving force in world economic growth. According to a recent outlook report from the Asian Development Bank, the region is projected to grow at 6.4 percent in 2015. Although continual regional cooperation tends to solidify Asia’s position as the driver of global growth, perhaps a more telling tale is the growth of individual economies within the region.

Southeast Asia’s two most populous countries, Indonesia and the Philippines, are projected to be the fastest-growing economies within the ASEAN+6 group, with an average annual growth rate of 6 and 5.8 percent, respectively, from 2014 to 2018, according to the OECD.

Southeast Asia’s two most populous countries, Indonesia and the Philippines, are projected to be the fastest-growing economies within the ASEAN+6 group. However, rising inequality remains a major challenge. Photo/Conor Ashleigh

Underpinning economic growth in Asia is not only the rise in domestic demand, particularly for middle-income countries such as Thailand and Malaysia, but also an increase in foreign investment in less developed countries such as Cambodia, Laos, Myanmar, and Vietnam. The World Bank is also forecasting accelerated economic growth in South Asia in 2015 and 2016, driven by an increase in private investment and export activity in India. Overall, the emerging Asian economies are expected to grow by 6.9 percent a year from 2014 to 2018.

Despite this impressive growth, Asia faces several major challenges. One is the uncertainty of China and India’s growth outlook in the long term and their capacity to implement policy reforms that will help them overcome their current deceleration in growth. For these Asian superpowers, as well as other economies across the region, the main challenges may very well be their capacity to overcome income inequality and to sustain their economies by adopting more environmentally friendly approaches. As the international community defines the post-2015 Sustainable Development Goals (SDGs), there is a general agreement that to accomplish higher levels of development, Asian economies have to achieve a more inclusive and sustainable growth.

Asia’s vulnerability: Rising inequality, lower economic mobility

After decades of sustained economic growth that has led to a substantial reduction in poverty, Asia is experiencing new social tensions and economic vulnerabilities due to the global economic crisis, slower growth rates in emerging economies, concerns about water and food security, and weak or nonexistent social safety nets. Rising inequalities and a growing demand for more equal opportunities make it imperative to think of economic growth in a more qualitative and inclusive manner, with not only less pronounced income gaps between the poor and the rich, but also better access to education and heath, and more equal opportunities to benefit from the “growth dividend.” Both the inequalities within countries as well as the disparities across economies are threatening the long-term growth prospects of Asia.

Indeed, over the past 20 years, the gap between Asia’s rich and poor has widened considerably. In the Asia-Pacific, the poorest 20 percent of the population accounts for less than 10 percent of national income. According to the latest Knight Frank wealth report, over the next 10 years, Asia will overtake Europe in terms of its billionaire population, with a forecasted 66 percent growth in the number of the ultra-high-net-worth individuals (UHNWIs – individuals with $30 million or more in net assets excluding their main residence), with the number of UHNWIs expected to grow by 80 percent in China, 99 percent in India, 144 percent in Indonesia, and a whopping 166 percent in Vietnam.

At the micro-economic level, rising inequalities mean lower economic and social mobility. This manifests in the inability of younger generations to earn more over their lifetime, or earn more than their parents did at a similar age. It also means fewer opportunities for the economies to benefit from the talents and economic contributions of the majority. At the macro-economic level, disparities among countries are also impeding the economic capacity of the region. For economies like Thailand and Malaysia, the threat of the middle-income trap is real. Lack of innovation, low investments in technology and education, rising labor costs, and stagnant productivity risk preventing or delaying these middle-income economies from shifting toward a higher-productivity economic structure.

In 2015, Asia will find that stronger regional economic cooperation, including through the South Asian Association for Regional Cooperation (SAARC) and ASEAN, will be essential to achieving more equitable and inclusive growth. This is no small feat, however. Public and private initiatives to increase intraregional trade, ensure competitive business environments, attract foreign and domestic FDI, and integrate SMEs into regional and global value chains should be made easier by the rise of Asian-led multilateral banks, the proliferation of free trade agreements, and progressive social policies that contribute to the region’s growth.

A call for green growth policies

Asia will also need to confront a host of mounting environmental challenges, including rapid environmental degradation, resource scarcity, and climate change. These problems compound the difficulty of reducing inequality, since they disproportionately affect the poorest and most vulnerable groups. In response, more countries are recognizing the need to transition to green growth strategies, incorporating environmental considerations into their national development plans to foster low-emission and sustainable, as well as socially inclusive, development. Sustainably managing resources can also serve as an important driver of growth, allowing countries to gain a competitive edge and spur greater job creation and prosperity.

The renewed focus on green growth could not have come any sooner. According to UNEP, the Asia-Pacific is now the world’s largest user of natural resources. The region’s rapid industrial development and export-led growth model has relied heavily on fossil fuel-intensive infrastructure and the exploitation of its natural resource base. This has led to a sharp rise in resource use and emissions in the Asia-Pacific – which continues to grow at a faster rate than any other region – as well as high levels of pollution and resource depletion. The economic impact of this can be staggering. In China, for instance, environmental degradation is estimated to cost the country approximately 9 percent of its gross national income, according to the World Bank. At the same time, domestic consumption in Asia continues to expand, creating unprecedented demand for more energy, clean water, and natural resources. If current rates of depletion continue, competition for resources will intensify.

Many Asian economies also remain highly vulnerable to changes in the world’s climate, which is expected to cause extreme weather, inland and coastal flooding, rising sea levels, heat stress, and famine. According to the World Bank, Vietnam leads the list of countries most threatened by rising sea levels, Bangladesh is considered the country most at risk of flooding, and the Philippines tops the list for more intense and frequent storms. The ADB also estimates that climate change damage could reduce economic growth in South Asia alone by 9 percent annually by 2100. And warmer weather could affect food production, causing it to drop in Bangladesh, Bhutan, India, and Sri Lanka by as much as 23 percent and increasing food insecurity for the poor.

These environmental challenges are often exacerbated by well-intentioned but harmful economic policies, such as fuel subsidies that encourage people to turn to inefficient, polluting forms of energy. In the past, many policymakers also remained skeptical on whether they could implement environmentally friendly policies without causing economic growth rates to drop. Yet 2015 is set to be a year when more countries shift to green growth strategies, acknowledging that these environmental and economic issues are interconnected and mutually reinforcing.

Because many of these challenges transcend national boundaries, they also provide an opportunity for greater regional cooperation. Governments not only need to include environmental considerations in their notion of sustainable economic growth, but also collaborate at the regional level to manage resources, reduce pollution, and increase energy efficiency.

The role of regional cooperation

After decades of looking to the West for trade markets and development assistance, Asia is starting to think and operate more regionally. The 10-member ASEAN and the 8-member SAARC groupings are taking the lead to strengthen trade and economic links in their respective regions. Regional initiatives such as the Regional Comprehensive Economic Partnership (RCEP) is primarily led and orchestrated by ASEAN nations, while the Asian Infrastructure Investment Bank (AIIB) is China’s attempt to offer its own brand of development assistance to countries in the region, while helping to close a very important infrastructure funding gap. These initiatives are further cementing Asia’s regional power ambitions.

However, Asia is still home to two-thirds of the world’s poor, and economic growth both domestically and regionally must aim to include the most vulnerable and disadvantaged. Increasing demand and rapid urbanization are also causing major constraints for resources in large populated areas, and as such pose a risk to the environment and emphasize the need for nations to seriously tackle the adverse impacts of climate change.

Regional cooperation has the potential for creating a marketplace for better-quality products at lower prices, better connectivity, reduced costs of production, and increased job opportunities, provided it is managed in a way that is conducive to a sound and transparent business environment. It also has the potential for greater vulnerability of the poorest if not well managed.

To be successful in the long term, regional cooperation will have to focus on more inclusive and sustainable growth. Similarly, in order to meet the ambitious post-2015 Sustainable Development Goals, governments, policymakers, social and economic actors, as well as the international community, will need to pay as much attention to regional challenges and regional governance as to domestic ones. If Asia can closely integrate as a regional bloc while moving toward a more inclusive and sustainable future, then the 21st century will definitely be the “Asian Century.”

Véronique Salze-Lozac’h is senior director for The Asia Foundation’s Economic Development Programs, and can be reached at [email protected]. Amy Warren and Nicolas Picard are program associates, and Ka Wai Wong is the Foundation’s Australian Youth Ambassador for Development in Bangkok. The views and opinions expressed here are those of the individual authors and not necessarily those of The Asia Foundation.

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