Asia’s economic freedom agenda

When I joined the Lee Kuan Yew School in January, I put on a new course on Asia in the World Economy. It covers East and South Asia – their historical and contemporary evolution in the global economy, the main countries and sub-regions, and key issues concerning policy and institutions.

Given such a wide sweep of “globalising Asia,” this is a mightily challenging course to teach, especially in eliciting comparisons and generalisations from such a diverse region. What follows are the generalisations I would highlight above all others.

Shifting East

The aftermath of the global financial crisis has reinforced a sense that the world is ‘shifting East’ – to Asia. But behind the dry numbers – and habitually overlooked – is the essential story of modern Asia – its unprecedented expansion of economic freedom.

What Adam Smith called ‘natural liberty’ – the individual’s ability to exercise choice in daily economic activity – has been on the march. Market liberalisation is its crucial enabler. Removing restrictions that repress economic activity has unleashed the animal spirits of ordinary people, and they are transforming Asia and the world in the process.

But there is much unfinished business, for economic freedom remains substantially repressed across Asia. Expanding it should be the leitmotif for public policy. This takes on added urgency in the current growth slowdown, caused by home-brewed policy failures and depressed export markets in the West.

Consider three key policy challenges to expand economic freedom.

Financial markets

First, financial markets. In most of Asia financial systems remain backward. Command-economy controls restrict opportunities for all but the politically well-connected and do a bad job of turning savings into productive investments. They restrict the transition from ‘catch-up’ growth to more advanced, sustainable growth based on productivity gains.  Enabling the transition to a more prosperous, sophisticated economy demands more financial freedom. That requires liberalisation: removal of interest-rate controls, opening to new entrants, including foreigners, broadening capital markets, and, ultimately, capital-account liberalisation.

Furthermore, ‘financial repression’ is at the core of ‘unbalanced growth’ – notably in China. It promotes over-saving and over-investment, while repressing private consumption, real wages and employment growth. China’s financial system channels – and wastes – massive amounts of capital through State-owned banks to State-owned enterprises while more efficient, labour-intensive private-sector firms are starved of funds. Financial liberalisation would liberate domestic private-sector growth, especially in services.

Trade and foreign investment

Second, trade and foreign investment. Liberalisation has created dynamic, globally-integrated, world-class sectors, especially in manufacturing in East Asia. But there are still large pockets of protectionism, with huge variation across Asia. Tariff barriers are still a problem, but a plethora of non-tariff barriers obstructs trade and foreign investment much more.

Most of these are embedded in complex domestic regulation. Domestic red tape – on property rights, contracts, licensing arrangements, paying taxes, opening and closing businesses, labour laws and customs procedures  – continues to stifle the business climate much more than in the West. This is reflected in the World Bank’s Doing Business Index. OECD countries occupy 8 of the top 10 places (Singapore and Hong Kong are in first and second place). Malaysia, Thailand and Japan are in the top 20. But China is 91st, India 132nd and Indonesia 129th.

Let us not forget that these regulations restrict economic freedom at the same time. The Fraser Institute’s Economic Freedom of the World Index has only two Asian societies – Hong Kong and Singapore – in the top ranks; the others are way behind.

Generally, Asian economic institutions – public administration, enforcement of property rights, domestic regulatory authorities – are relatively weak and keep business and trade costs high, repressing entrepreneurship, innovation and consumption. They also result in badly integrated regional markets, beset by high intra-regional barriers to trade, investment and the movement of workers – a far cry from the EU and NAFTA.

Energy and the environment

Third, energy and the environment. Energy consumption in developing Asia is expected to double over the next two decades. That translates into much more demand for fossil fuels. China and India will import much more oil, natural gas, and coal. Asia should also exploit ‘fracking’ technology and reap massive benefits from shale gas. But energy markets are throttled by government intervention and state-owned enterprises. Price controls, subsidies, export restrictions and inward-investment restrictions are the norm.

Energy is hardly covered by WTO rules. China and India are attempting to secure energy supplies through command-economy rather than market instruments – sending out highly subsidised national oil companies, striking long-term contracts with foreign governments, and pledging loans for oil. These measures make energy markets pricier and more volatile, and they exacerbate geopolitical tensions.

More energy freedom is required to cater to rising consumption, make energy supplies more stable, secure and cost-effective, and to preserve peaceful international relations. That means liberalisation: removing price controls and subsidies, encouraging private domestic and foreign investment, ‘unbundling’ generation, transmission and distribution in the power sector, and freeing international trade.

Increasing Asian consumption of fossil fuels to power industrialising growth translates into rising carbon emissions. However, according to the climate-change consensus, Asia – particularly China and India – will need to commit to binding targets to cap and then reduce overall carbon emissions sooner or later. That will likely lower growth potential.

Here scepticism is in order. Climate science is not ‘settled,’ contrary to the conventional wisdom. Much of it pays too little account to long-range uncertainty. That is also true of much of the accompanying economic analysis, such as the UK’s Stern Review and Australia’s Garnaut Review. Their proposals – on taxes, binding targets, quotas, subsidies and massive aid transfers – owe more to soft central planning than anything else. They constitute a huge threat to economic freedom.

Adaptation to global warming through market-based energy efficiency measures is advisable, but so is scepticism regarding mainstream advocacy of carbon reduction.

First and second generation reforms

Now for some concluding observations.

First, Asia’s poorer economies – those in the low-income and least-developed brackets – should concentrate on ‘first generation’ reforms for catch-up growth. This involves a combination of macroeconomic stabilisation and market liberalisation.

‘Getting the basics right’ – prudent fiscal and monetary policies, removing price controls and wasteful subsidies, and freeing up international trade and foreign investment, inter alia – will provide the right environment for mobilising savings and investment, labour and capital. Most of South Asia, the poorer Southeast Asian countries, and the poorer parts of China (its interior provinces) are in this growth phase.

Second, Asia’s middle and high-income economies have unfinished business with first-generation reforms. But they should also focus on ‘second generation’ reforms – more complex structural reforms in the thickets of domestic regulation – to boost competition, innovation and productivity gains.

Among needed structural reforms are nitty-gritty measures to cut red tape and improve the business climate; liberalising labour, energy and financial markets; shrinking the public sector and opening it up to competition; and bringing competition to education, health care and other public services.

Structural reforms also dovetail with institutional reforms: strengthening private property rights and the enforcement of contracts; building a more sophisticated legal system and entrenching a real – not a sham – rule of law; making public administration leaner and more efficient; and establishing transparent, clean and competent regulatory agencies. Institutional reforms, in essence, are all about the reform of the state itself.

Asia’s richest countries – Japan, South Korea, Taiwan, Hong Kong and Singapore – have made the transition to middle- and now high-income status. Their challenge is to drive specialisation, product differentiation and innovation in established and new global-market niches. Malaysia and Thailand, in contrast, risk being stuck in the middle-income trap for lack of structural reforms. So do the relatively wealthy coastal provinces of China – and indeed China as a whole as it grows closer to middle-income status over the next decade. And the same applies to the wealthier parts of India.

Political reforms

Third, economic reforms to expand economic freedom beg the question of political reforms to expand civic and political freedoms. The track record in Asia and elsewhere shows that catch-up growth is compatible with a variety of political systems, ranging from authoritarianism to democracy.

Liberal institutions and open societies, with their plural ideas and their checks and balances, are not a prerequisite for catch-up growth. But unreformed autocracies, with unchecked vested interests at their core, are badly fitted to undertake structural and institutional reforms.

Expanding economic freedom, embodied in the rising expectations of a burgeoning middle class, comes into conflict with straight jacketed, Neanderthalic politics. Now the link between political and economic reforms becomes stronger. Will Asian institutions adapt? Or will political sclerosis keep countries stuck in a middle-income trap – or worse? This is a mighty Asian challenge – not least for China.

Economic liberalism

Finally, my message is a classical-liberal one in the spirit of Adam Smith and David Hume. Freedom and prosperity have bloomed on Asian soil because government interventions have been curtailed and markets unleashed. Pace fans of the ‘developmental state,’ the Asian miracle is not the product of superior technocratic minds who concocted industrial policies to promote targeted sectors. Indeed there is scant evidence – only assertion – that such social engineering worked.

Limited government – a ‘strong but small’ state that performs its core functions well but does not intervene left, right and centre – free markets at home and free trade abroad: that is the ‘system of economic liberalism,’ as Joseph Schumpeter called it, to which Asians should aspire.

(This article is excerpted from the Gamani Corea Lecture delivered by the author recently at the Marga Institute. He is a Visiting Associate Professor at the Lee Kuan Yew School of Public Policyand the Institute of South Asian Studies at the National University of Singapore.)