Deepening East Asia and Pacific success in the midst of uncertainty

The region has transformed from one of low-income and largely agricultural economies to one of middle-income and highly sophisticated economies with growing middle classes. The region now acts as an engine of growth for the global economy, accounting for more than a third of global GDP growth last year.

This success story permeated many of the discussions and events during the recent World Bank-IMF Annual Meetings in Bali, Indonesia. From the high rankings of many East Asian countries in the newly released Human Capital Index, to the substantive discussion around the ‘East Asian Miracle’ and its future, the week served to showcase how far the region has come and its significant potential to achieve even greater success.

While prospects for the region’s continued development remain favorable, EAP countries will have to navigate heightened global uncertainty and headwinds that have emerged in recent months: trade tensions, weakening global trade, tightening financing conditions, bouts of portfolio capital outflows and pressure on asset markets.

Growth among developing countries in East Asia and the Pacific has thus far remained resilient in 2018, underpinned by still-strong domestic demand. However, the deteriorating global trade and financing conditions could erode fiscal and financial buffers and depress medium-term growth prospects in the absence of sound policy responses.

The slowdown in world trade growth is of particular concern to the region, as East Asia accounts for almost a sixth of global trade. While some may favor protectionist measures to preserve jobs, in many countries, these measures have the unintended consequence of hurting exports and investment as imports of intermediate inputs and capital goods dominate imports.

There is strong evidence that economies and people benefit from more open trade, not less. Trade openness can help reduce costs and prices to consumers, while domestic firms can benefit from more and better intermediate inputs.

To mitigate the potential impact of rising global trade tensions, countries in the region could accelerate their economic integration under the ASEAN and as part of the wider Regional Comprehensive Economic Partnership (RCEP) that is been negotiating over the last several years.

The RCEP, which aims to consolidate ASEAN’s bilateral Free Trade Agreements with Australia, China, India, Japan, New Zealand and the Republic of Korea, would be the world’s largest trade bloc, with a population of 3.5 billion people and a GDP of $23.8 trillion.

Deeper regional trade integration would therefore provide all participating countries with a large export market, which could mitigate the loss of export caused by ongoing trade tensions.

Deepening existing agreements to include such areas as public procurement, subsidies, protection of intellectual property, and stronger competition policies could allow greater specialization, and strengthen global and regional value chains. Expanded trade in services could be a strong driver for productivity growth while compensating for slowing global goods trade.

The tightening of global financing conditions, triggered mainly by rises in US interest rates, may continue in the coming months, as signaled by the US Fed in its September 26 statement.

While EAP countries enjoy stronger economic fundamentals than many other developing countries, rapidly rising US rates can lead to bouts of short-term portfolio capital outflows from the region. This risk is largely beyond the control of countries in the region but there is a lot that they can do to strengthen resilience of their economies.

Each country in the region can take a hard look at potential sources of erosion of their economic resilience or potential sources of vulnerability and address them promptly. Keeping debt levels and fiscal and current account balances at sustainable levels is important.

Addressing financial sector weaknesses, where these apply, will also be essential in reducing risks. And a judicious mix of prudential regulation, exchange rate flexibility, and the build-up of fiscal buffers can help.

Many countries in the region already have flexible exchange rate systems. Continuing this flexibility can dampen the domestic impacts of external shocks, including volatile capital flows.

With risks intensifying, building fiscal buffers and strengthening debt sustainability can also help strengthen resilience. Refocusing fiscal policy to raise more revenues efficiently and better prioritizing public spending can help to protect stability while sustaining growth and fostering inclusion.

The efforts to collect more revenues and build fiscal buffers are crucial to maintain critical investments in human capital and social protection even when inevitable economic shocks occur.

Providing opportunities for quality education, improved health care, and better nutrition helps build human capital. Without it, countries in the region will find it more difficult to sustain growth, prepare their workforce for the highly-skilled jobs of the future, or ensure inclusive development.