Analyzing ASEAN

    This article assesses the economic and political evolution of ASEAN, from the bloc’s foundation in 1967 to the present day, and looks ahead at what is in store over the coming years. It places special focus on the Asian Financial Crisis and the Global Financial Crisis, two events which tested the ties between members. The article concludes with the ASEAN economic outlook from the FocusEconomics Consensus Forecast

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South-East Asia in the late 1960s seemed an unlikely time and place for the birth of one of the world’s leading trade blocs. From 1963–1966, Indonesia and Malaysia had been embroiled in an undeclared war over the creation of the Federation of Malaysia—the very same Federation from which Singapore had just been unceremoniously ejected, following deadly race riots between Malays and Chinese which left dozens dead. Malaysia and the Philippines were at loggerheads over the sovereignty of North Borneo. And Vietnam and Laos were in the throes of civil wars, which pitted communist insurgents against U.S.-backed regimes.

Yet it was precisely the rise of communism which encouraged other countries to put aside their differences and band together. In early August 1967, in an event which has since become part of ASEAN folklore, the foreign ministers of Indonesia, Malaysia, the Philippines, Singapore and Thailand met at a secluded beach resort in southern Thailand.

As ASEAN’s own website eulogizes: “it was by no means an easy process: each man brought into the deliberations a historical and political perspective that had no resemblance to that of any of the others. But with goodwill and good humor, as often as they huddled at the negotiating table, they finessed their way through their differences as they lined up their shots on the golf course and traded wisecracks on one another’s game”.

This informal meeting gave rise to the Bangkok Declaration, and with that the Association of Southeast Asian Nations (ASEAN) was born.

Fast forward just over half a century, and economic progress has undoubtedly been impressive: GDP per capita has soared, poverty has plummeted and barriers to trade between members have fallen. Politically, the bloc’s voice has grown louder on the world stage, the number of members has doubled, and the institutional structure has been strengthened through the ASEAN Charter. Economic prospects for the years ahead are rosy. ASEAN loftily describes itself as “probably the most successful inter-governmental organization in the developing world today”.

Nevertheless, challenges remain. While goods tariffs have largely been eliminated, non-tariff barriers persist, and trade in services, capital and labor is subject to restrictions; labor productivity is feeble by global standards, which could see the region left behind in the sweeping changes to industry expected over the next decades; and demographic transitions will pose problems for policymakers going forward. How governments respond to these issues will determine whether the next 50 years are as economically successful as the last half a century.

 

  • TAKING STOCK

Today, ASEAN comprises 10 countries—namely, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam—with a combined population of 647 million and total nominal GDP of USD 3 trillion in 2018. If ASEAN were a single economy, it would currently rank as the world’s fifth largest.

Since 2000, economic growth has been the envy of most other regions at an average 5.2%—a rate only bettered only by East Asia and South Asia, which benefited from the stratospheric rise of China and India respectively. Higher wages and employment drove private consumption, while a low-cost base made the bloc an attractive destination for FDI, which, coupled with strong infrastructure spending, supported fixed investment. Regional exports have benefited hugely from the emergence of China as an economic force, and ASEAN has becoming increasingly plugged into the Chinese supply chain. Tourism has also taken off: International visitor arrivals have more than tripled.

However, taking ASEAN as a whole masks gaping disparities which dwarf those in any other regional trading bloc. ASEAN encompasses both Indonesia, a trillion-dollar economy with a population over 250 million, and Brunei, with a population smaller than most medium-sized cities. In terms of GDP per capita, the difference between Singapore, the wealthiest ASEAN member, and Myanmar, the poorest, is close to 50 times. The corresponding figure for the EU—itself a highly unequal union—is just 12.

Economic structures are also radically different. In poorer ASEAN members such as Cambodia, Laos and Myanmar, agriculture still accounts for a significant share of GDP, just as manufacturing is a crucial economic sector in Indonesia, Malaysia, and Thailand. Meanwhile, Singapore is overwhelmingly service-dominated and Brunei is built on the energy sector.

Several ASEAN nations rely heavily on external trade to fuel growth, as is the case for Cambodia, Malaysia, Singapore, Thailand and Vietnam, where total trade represents over 100% of GDP. Other countries are more domestically driven; for instance, Indonesia and the Philippines boast large internal markets for their goods and services, while Myanmar’s economy was relatively closed to the outside world until recently.

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With regards to economic policy, ASEAN is only loosely meshed together. Members apply no common external tariffs on goods originating from outside the bloc, and are free to conduct their own trade agreements. Countries have taken full advantage of this freedom: Singapore and Vietnam have recently negotiated free trade deals with the EU, while Indonesia has inked an agreement with the European Free Trade Association (EFTA).

However, ASEAN has also struck deals as a whole to maximize negotiating clout. Such trade agreements are currently in place with neighbors Australia, China, India, Japan, Korea, and New Zealand. Efforts are currently underway to package all of these existing bilateral deals into a mammoth Asia-wide pact, dubbed the Regional Comprehensive Economic Partnership (RCEP), which would cover close to half the world’s population.

Within ASEAN, trade in goods is largely tariff-free: 98.7% of tariffs had been eliminated by 2018. Moreover, the organization has taken steps to harmonize customs regulations via the ASEAN Single Window and moved to boost labor mobility through mutual recognition agreements for eight key professions. The ASEAN Banking Integration Framework aims to boost cross-border access for certified banks, while the ASEAN Single Aviation Market, which is still under negotiation, aims to turbocharge intra-regional travel. And the ASEAN Economic Community, heralded as a major milestone when set up in 2015, signals the bloc’s intention to deepen integration and turn ASEAN into one cohesive market, in order to better attract FDI and compete on the world stage.

In contrast, there is little appetite for a close political union such as that of the EU; the ability for each country to pursue its own policy objectives is considered paramount. That said, the ASEAN Charter—which came into force in 2008—has enhanced political collaboration, by solidifying the bloc’s institutional framework and establishing new decision-making bodies.

 

  • STAYING POWER

Two defining moments have tested ASEAN’s resilience since its foundation. The first major hurdle was the 1997–1998 Asian financial crisis. The early to mid-1990s were boom times for ASEAN, with growth averaging over 7% annually in many countries. It was an age of optimism, and foreign capital flooded in, attracted by solid economic prospects and high domestic interest rates.

However, vulnerabilities grew in tandem, and sizeable current account deficits, profligate lending, soaring asset prices and rising USD-denominated debt foreshadowed the crash to come. External conditions grew more adverse as the Federal Reserve began to hike rates and prices for semiconductors—a key ASEAN export—declined. Events came to a head in mid-1997, when the Thai Central Bank was forced to abandon its dollar peg after investors took aim at the currency. The Malaysian ringgit and Indonesian rupiah were the next in line as investors withdrew funds, with the latter collapsing from IDR 2,400 per USD in mid-1997 to above IDR 10,000 roughly six months later. The currencies of the Philippines and Singapore were also hard hit.

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The currency crash forced central banks to jack up interest rates, which, coupled with collapsing confidence, crushed domestic demand. GDP contracted in 1998 in many ASEAN members, with Indonesia and Thailand forced to seek unpopular IMF bailouts.

ASEAN economies recovered remarkably quickly from the crisis, with growth returning the following year thanks to healthy private consumption, strong world demand for electronics and sound macroeconomic management. Structural reforms also played a key role in boosting sentiment, with governments cleaning up their corporate and financial sectors. When set alongside the robust expansions observed before and since, the Asian financial crisis seemed nothing but a blip on ASEAN’s economic radar.

The political scars arguably took longer to heal. The crisis laid bare ASEAN’s limitations; the bloc lacked risk-pooling mechanisms, or the institutional and economic means to provide a unified response to the crisis. Countries adopted divergent coping strategies. While Thailand and Indonesia sought financial assistance from the IMF, Malaysia resisted the Fund’s siren call and instead imposed capital controls.

One decade later, ASEAN was forced to weather another storm: the global financial crisis. But this time things would be different. Although exchange rates took a hit—notably in Indonesia and the Philippines—the impact was far less severe than in 1997–1998. While some countries did dip into recession, there was no collapse in investor confidence, and no IMF bailouts. Economic activity was undoubtedly supported in part by China’s huge stimulus program, which propped up economies across the region. However, domestic factors should not be underestimated. ASEAN nations implemented deep structural reforms in the years following the Asian financial crisis. And compared to a decade earlier, external debt was far lower and international reserves much higher, dampening external vulnerabilities.

 

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The bloc’s political evolution, while still tangible, was arguably less far-reaching. ASEAN still lacked substantive economic risk-pooling mechanisms to help countries in trouble. The Chiang Mai Initiative, a currency swap agreement first established in the wake of the Asian Financial Crisis, proved inadequate. When the 2008 crisis hit, members bypassed the initiative; for instance, Singapore’s central bank secured a liquidity swap deal with the Federal Reserve. However, the strong fundamentals of the region’s individual economies meant overarching institutional flaws were less exposed compared to a decade earlier.

 

  • NOT QUITE SHANGRI-LA

ASEAN’s economic integration is also far from seamless. Despite undoubted progress in ditching goods tariffs, non-tariff measures have often sprung up in their place: Total non-tariff measures more than tripled from 2000 to 2015. This has stunted regional trade, as reflected by intra-ASEAN trade as a percentage of total ASEAN exports stagnating at around 25% over the last decade, far below the corresponding figures for trade blocs such as NAFTA or the EU.

Restrictions remain in markets for capital, labor and services, despite recent initiatives—such as those promoting banking integration, mutual recognition for key professions, and aviation integration—and the upbeat rhetoric and ambitious goals set out in the 2025 blueprint. Moreover, even the blueprint itself is not advocating a seamless single market. For instance, the aim is to achieve only free movement of skilled labor, meaning many workers would still struggle to settle in another member state.

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Political considerations could hamper further progress. For starters, the further liberalization of labor markets could be explosive. Take Singapore, for example, where the large influx of immigrants in recent years has triggered popular backlash. And poorer ASEAN members may lack the institutional means to swiftly implement a far-reaching economic integration plan. This could lead to a two-speed ASEAN, with the ASEAN 5 (Indonesia, Malaysia, the Philippines, Thailand and Singapore); Brunei; and, potentially, Vietnam steaming ahead with further reforms, and the rest of the bloc playing catch-up. This divergence is already present to an extent: Cambodia, Laos, Myanmar and Vietnam were given longer to enact recent tariff reforms for instance.

Economic nationalism could also hinder integration efforts, with some ASEAN governments having arguably taken a more nativist approach to policymaking in recent years. Indonesia, for example, part-nationalized the huge Grasberg mine in 2018, while the new Malaysian administration recently threatened to scrap a flagship Chinese infrastructure project, before finally agreeing a much slimmed-down version of the scheme.

 

  • LOOKING AHEAD

Even if the bloc’s integration stalls over the next few years, near-term growth prospects are still glowing compared to other emerging-market regions. Our panelists currently see GDP growth averaging 4.8% through to 2023. Surging fixed investment, public infrastructure drives, employment growth and strong wage gains should buoy the economy, and the bloc will seemingly continue to gain market share in global export markets—particularly if RCEP negotiations are wrapped up. Smaller economies such as Cambodia, Laos and Myanmar, meanwhile, ought to benefit from Chinese FDI inflows and tourist arrivals.

The chief risk is an escalation of the U.S.-China trade conflict. Given that the world’s two superpowers are key export markets, a trade-war induced global slowdown would dampen the appetite for ASEAN goods. The bloc would also lose out due to the importance of intermediate goods exports to China, which are then re-exported to the U.S. And ensuing uncertainty in financial markets could hit the currencies of economies with weaker external positions, such as Indonesia and the Philippines; over the last year, the Indonesian rupiah in particular has proved highly sensitive to changes in global risk sentiment.

However, there are upsides to the dispute. ASEAN is poised to benefit from the relocation of production facilities from China, and trade diversion, as the two giants buy less of each other’s goods and more from the rest of the world. Vietnam has been the biggest winner so far, thanks to its low-cost base and stable business climate which is reminiscent of a young China. FDI in the country has surged this year, while U.S. imports from Vietnam were up 40% year-on-year in Q1 2019.

While U.S. tariffs on Chinese manufactured goods should support American demand for ASEAN’s electronics exports, Chinese tariffs—which have been predominantly imposed on agricultural produce so far—stand to boost shipments of products such as beef from Myanmar, pork from the Philippines, fruits from Thailand and palm oil from Malaysia.

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Looking further ahead, favorable demographics will galvanize growth. Around 50 million people will join ASEAN’s workforce between now and 2030—only India can boast a higher figure. Several economies, including regional heavyweights Indonesia and the Philippines, are set to benefit from demographic dividends—a period when the proportion of working-age adults is very high— over the coming decades. This should leave government coffers flush with cash, which, if used wisely, could rapidly upgrade physical and human capital.

But there is a flipside to this frothy labor supply growth. Governments will be under pressure to ensure jobs for those joining the labor market, or else risk social instability. Meanwhile, countries such as Thailand and Singapore—and, to a lesser extent, Malaysia and Vietnam—will face the opposite problem, burdened by low fertility rates and rapidly ageing populations. Rising health spending will pose a challenge for policymakers in coming decades, and put pressure on fledgling pension systems.

The fourth industrial revolution is another key long-term risk. The manufacturing sector, which today is worth some USD 600 billion in value added, has been the linchpin of ASEAN’s growth trajectory. However, the sector could be under threat from sweeping technological change. The arrival of mass 3D printing will likely see a process of onshoring, as production facilities shift back to developed economies to be closer to end markets. This could harm manufacturing jobs and investment in ASEAN, particularly given that the bloc—with the exception of Singapore, a global leader in 3D printing—lags behind in the field.

Equipping ASEAN’s workforce with the skills to thrive in this new world will be crucial. Currently, labor productivity in many ASEAN countries languishes below that of other emerging markets, and there is a considerable reliance on primary or cheap manufactured exports. Public policies to improve the quality of education and training and move up the value chain are needed.

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Such challenges would have surely been accepted gladly by the five founding fathers back in 1967, as they hunkered down in a secluded beach resort to shape the region’s future. The problems at the time were far more acute: political antagonism, civil war and extreme poverty. Today, ASEAN is at peace, economically flourishing and brimming with a new-found self-assurance. Buoyed by past successes, the current crop of leaders will have every confidence that the next 50 years will be just as transformative.


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Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Oliver Reynolds, Economist

Date: August 14, 2019

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