In many ways, Cambodia is Asia’s true miracle economy. It was only three decades ago when the Paris Peace Agreements were signed, ending the civil war that ensued following the ouster of the genocidal Khmer Rouge regime in 1979. In just over a generation, Cambodia has built up its economy and institutions, almost from scratch, and transformed itself into a modern, thriving economy. Although many challenges remain, these achievements must be recognized and bodes well for the future, given Cambodia’s proven ability to overcome seemingly insurmountable odds.
Despite its tragic history, Cambodia has great aspirations. It aims to become an upper middle-income country by 2030 and a high-income country by 2050. To realize these aspirations, Cambodia has to pursue inclusive growth that is also sustainable and resilient. This type of growth should be driven by and generate decent and sustainable jobs in the manufacturing and services sectors, and fair and sustainable returns for the self-employed, either in agriculture or in the MSMEs across sectors, formal or informal. To do this, it has to address a number of constraints.
Inter- and Intra-sectoral Diversification
A key constraint, which is highlighted in the Rectangular Strategy (Phase IV) and the Pentagon Strategy (Phase I), is the lack of diversification of the economy. The continued lack of diversification has not affected the rapid pace of economic growth but only its quality and inclusiveness. Cambodia’s growth exceeded an average of 7% in the decade prior to the pandemic, driven by trade preferences, tourism centered around Angkor Wat, and large capital and aid inflows from China and other regional partners into infrastructure and real estate. With LDC graduation expected this decade, Cambodia will become a victim of its own success and trade preferences and aid flows are likely to diminish. It will need to pursue new drivers of growth, which will require new and greater diversification.
The early phase of diversification or structural transformation, involving rural-urban migration from the agricultural sector into the industrial and services sector, has been ongoing but may be reaching its limit. This inter-sectoral transfer of factors of production is the easy phase of diversification, requiring minimal government intervention or policy reform, and takes place somewhat naturally with minimal disruption to factor markets. The horizontal shift across sectors into higher value products and activities produces a one-off increase in the level of productivity, which raises incomes and living standards, but this increase may not be sustainable.
Future increases in productivity will have to come from intra-sectoral diversification. This involves the vertical shift into higher value-added products and activities within the industrial, services and agricultural sectors. This type of diversification is sometimes referred to as moving up the value-chain by engaging in higher value-added activities and in manufacturing, is associated with greater participation in global value or supply chains. Unlike the early phase of industrialization, this process of upgrading is unlikely to happen naturally and will require government intervention and/or policy reforms.
Addressing Three Key Constraints
There are three major constraints that need to be addressed through policy reforms and government support to enable greater intra-sectoral diversification. The first is limited human capital and skills mismatches. Second is the high cost of doing business, which limits development of the private sector and domestic and foreign investment. Last is the lack of resilience and sustainability, which threatens current and future growth.
There is an urgent need to improve the quality of education at all levels, and not just TVET or tertiary education. TVET and tertiary education can only succeed if students have had a strong educational foundation in primary and secondary schooling. Quality improvements also need to be accompanied by measures to improve access and retention rates, which are currently low.
Cambodia needs to invest in skills development and training in close collaboration with the private sector to avoid skills mismatches. TVET and tertiary education institutions need to align their curricula more closely with the needs of the private sector.
Second is the high cost of doing business in Cambodia, which stems from limited physical and logistics-related infrastructure, high energy cost, and the high cost of finance. There is a need to prioritise investments both within the transport sector, as well as economy-wide.
The high cost of electricity is limiting vertical upgrading within electronics and automotive supply chains, from labour-intensive assembly activities to higher value added, energy intensive production of parts and components. Greater investment in renewable energy and energy efficiency is required to reduce costs and the reliance on diesel and heavy fuel oil in electricity generation.
The high cost of finance, especially to small scale farmers and MSMEs, perpetuates poverty. Limited access to formal avenues of finance is closely related to its high cost. The potential for digital innovation, including fintech and blockchain, presents significant opportunities for Cambodia’s financial sector to enhance financial inclusion.
There are also a host of long-term development challenges that need to be addressed that will affect trust in the system, and therefore both the access to and the cost of finance. These include issues relating to governance and corruption, the quality of institutions including the legal and regulatory system, and the development of the finance sector and capital markets.
Resilience and Sustainability
Finally, there is a need to increase versatility in managing and responding to disruptions and ensuring the sustainability of growth and its drivers. Increasing resilience include addressing the impacts of: (i) climate change and other environmental pressures; (ii) financial, health and other shocks or crises; and (iii) technological change, especially the acceleration towards a digital economy. Improving the sustainability of growth and its drivers involve diversifying trade and investment flows. That is, diversifying export products and markets and import sources will reduce risk and increase the sustainability of economic growth. Policies and interventions to address each of these are discussed in turn, below.
Climate change threatens the livelihoods of millions as well as long-term aspirations such as reaching high-income status by 2050. A recent ADB study suggests that Cambodia’s GDP could be up to 10% lower than otherwise in 2050 due to lost labor productivity.
Economic growth and environmental protection are often considered trade-offs but there can be complementarity. The intersection between the two is green growth, where ecologically sustainable economic growth that fosters low carbon but socially inclusive development is the outcome.
Transitioning away from the heavy reliance on fossil fuels, reducing the rate of deforestation and adopting more sustainable agricultural and fishing practices will be critical in protecting the environment and ensuring the future prospects of these industries.
As green and sustainability aspects of production become increasingly important in business and investment decisions of international firms, reducing its carbon footprint would present Cambodia with new growth opportunities that arise from increasing global demand for environmentally sustainable products and services.
Cambodia will need to strengthen its financial sector resilience by enhancing regulatory and supervisory frameworks, improving asset quality and risk management practices, and addressing weaknesses in the banking system. There is a need to implement regulations to deal with bank restructuring, corporate insolvency, and debt restructuring.
Although Cambodia did remarkably well in managing the COVID-19 pandemic, it highlighted a number of vulnerabilities in the healthcare system that need to be addressed before the next health emergency occurs. Government spending on healthcare needs to be significantly increased in preparation for the next pandemic or major public health outbreak. There are currently only 0.7 hospital beds per 1,000 people, compared to 2.6 in Vietnam and an average 4.7 amongst the OECD countries. This was a major limitation in managing the COVID-19 pandemic, requiring more stringent controls than in countries with more robust healthcare systems.
The acceleration towards a digital economy will produce many benefits, but it will also create new challenges. Many low- and medium-skilled jobs may be lost initially, although Artificial Intelligence threatens even highly skilled ones. It will not be easy to redeploy low-skilled workers and reskilling and retraining will be required.
Cambodia’s trade patterns – both the commodity and country composition of its exports and imports- are highly concentrated, raising its vulnerability to country- or commodity-specific shocks. As the major constraints to structural diversification such as limited human capital and high business costs are addressed, trade and investment flows will also diversify. For instance, if the price of electricity could be reduced, this could attract new types of FDI from different source countries, which would result in new types of output such as electronic parts and components. This alters both the commodity and country composition of exports and imports, helping diversify trade and investment patterns.