INTRODUCTION

It is generally said that economic regionalism has a positive impact on economic development as it strengthens economic linkages through trade and investment and encourages the development of production networks. Sen (2007) in his analysis of ASEAN regionalism observes that ASEAN has the potential to promote economic development and facilitate the newer and economically less developed ASEAN members in building up production networks that would facilitate the economic integration process.

In this context, this chapter examines ASEAN economic integration and its implications for the CLMV countries, namely Cambodia, Laos, Myanmar and Vietnam. The chapter begins by giving a background on the ASEAN Economic Community and discusses its origin, rationale and challenges. It then looks at the development divide within ASEAN. It is observed that while the different levels of economic development can be complimentary in nature and therefore facilitate production network development, infrastructure and social gaps can be hurdles for reducing costs. The chapter also examines in more detail the extent of integration of Cambodia, Laos and Vietnam within ASEAN and the rest of the world. Finally, prior to providing some concluding remarks, the chapter analyses the role of free trade agreements (FTAs) in strengthening production networks in the region, especially in the light of newer members of ASEAN.

THE ASEAN ECONOMIC COMMUNITY

ASEAN, established in 1967, is one of the world' most successful regional organizations. It comprises ten countries, namely, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. ASEAN countries combined constitute a population of about 567 million, spanning a total area of 4.5 million square kilometers. In 2006, ASEAN generated a combined gross domestic product of US$1.07 trillion and total trade of US$1.44 trillion, accounting for more than a quarter of Asia' total exports and imports.

Since its inception, ASEAN has managed to successfully foster closer political and security cooperation, creating a peaceful and stable region. As a result, ASEAN, especially its five original members (ASEAN-5), i.e. Indonesia, Malaysia, the Philippines, Singapore and Thailand, enjoyed impressive economic growth rates, reduced poverty and improved living standards over the past three decades. However, in recent years, the region has begun to face stiff competition from China, particularly in attracting foreign direct investments (FDIs).

Introduction

Like many economies in Southeast Asia, Malaysia currently faces a number of challenges that could have a significant impact on its economic growth and development.Despite the fact that 2007 was generally seen as a good year economically, events in the second half of the year, particularly the U.S. sub-prime mortgage crisis, and poor U.S. economic data could trigger a recession in the world's largest economy, which in turn could lead to a global slowdown in 2008. Added to these concerns are the high oil prices and rising food and commodity prices, which could stoke fears of global inflation. All these downside risks would clearly affect macroeconomic stability in the region. Against this backdrop, Malaysia's relatively good economic performance in 2007 may be insufficient to guarantee that the country will be immune from the downside risks faced by the rest of the world.

At the same time, Malaysia is currently going through a challenging period in its economic development as it attempts to maintain its economic competitiveness vis-à-vis the emerging economies of China, India and, closer to home, Vietnam. Like a number of middle-income developing countries in the region, Malaysia has economically been “punching below its weight” in the sense that it is not maximizing its full economic potential. To address these challenges, Malaysia has been trying to develop two ambitious economic corridor projects that could revitalize its economy.

These two economic corridors are the Iskandar Development Region (IDR) in South Johor (which borders Singapore) and the Northern Corridor Economic Region (NCER) in the northern Peninsular Malaysia. Besides reviewing Malaysia's economic performance in 2007, this chapter will examine the development of these two economic corridors.

Economic Performance in 2007

Malaysia's economic performance in 2007 was better than market expectations. The country registered a real GDP growth rate of 6.3 per cent in 2007 (the economy grew 5.9 per cent in 2006) which was higher than the Malaysian Institute of Economic Research's (MIER) projection of 6.1 per cent (see Table 1 and FIgure 1). A better than expected fourth quarter economic growth rate of 7.3 per cent helped to push up the overall economic growth for the year.

The vision of an ASEAN Economic Community (AEC) by 2015 is certainly bold and ambitious. Although there are already building blocks in place such as the ASEAN Free Trade Area (AFTA), the ASEAN Investment Area (AIA) and the ASEAN Framework Agreement on Services (AFAS), ASEAN faces a number of daunting challenges in realizing this vision. From the studies presented in the preceding chapters, a number of compelling questions emerge. Among these are:

1. (i) whether or not the roadmap to achieve the AEC is realistic given the relatively short timeline set to undertake this endeavour;

2. (ii) whether the progress made in expediting economic integration, particularly of the fast-track integration of the priority sectors, is on track to achieve its targets and objectives;

3. (iii) whether ASEAN has the institutional framework to support such deeper economic integration; and

4. (iv) whether ASEAN would be able to successfully address the economic development divide among its member countries.

There is also the nagging question of what is the ultimate end-goal of the AEC — is it a European-style common market or just a free trade area? To be sure, these challenges need to be seriously addressed in the short to medium term. In this concluding chapter, key issues are discussed reflecting the challenges ahead.

Addressing the Stumbling Blocks to Economic Integration

Tackling Barriers to Trade

Although most ASEAN countries have complied with tariff reductions under AFTA, Tongzon (2005) found the utilization of the Comprehensive Effective Preferential Tariffs (CEPT) has been relatively low due to lack of clear and transparent procedures, a lack of mutual trust between preference-receiving country and preference-granting country, low margin of tariff preferences (between CEPT and most-favoured nation rates) and a lack of private sector awareness regarding AFTA concessions. Furthermore, the less developed ASEAN countries may be reluctant to fully implement AFTA given the huge losses in customs revenue due to the implementation of the CEPT (Tongzon and Khan 2005). Intra-ASEAN trade has not increased significantly since the signing of AFTA in 1992 (see Figure 10.1). Studies in this book on the priority sectors have also found that non-tariffs measures (NTMs) continue to persist and impede greater intra-ASEAN trade. Hence, effectively tackling NTMs, particularly those that are barriers to trade, would be crucial if a fully functioning AFTA is to be feasible by 2015.

Introduction

The Association of Southeast Asian Nations (ASEAN) is one of the world's most successful regional organizations. Established on 8 August 1967, ASEAN consists of ten member countries, namely, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

ASEAN countries combined constitute a population of about 567 million, spanning a total area of 4.5 million square kilometres. In 2006, ASEAN generated a combined gross domestic product of US$1.07 trillion and total trade of US$1.44 trillion, accounting for more than a quarter of Asia's total exports and imports.

Since its inception four decades ago, ASEAN has successfully managed to foster closer political and security cooperation, creating a peaceful and stable region. As a result, ASEAN, especially its original five members (ASEAN-5), i.e., Indonesia, Malaysia, the Philippines, Singapore, and Thailand, has enjoyed impressive economic growth, reduced poverty and improved living standards over the past three decades.

Although many ASEAN countries were severely affected by the 1997 Asian financial crisis, their economies have recovered ten years on. However, during this time the region has begun to face stiff competition from China, particularly in attracting foreign direct investments (FDIs). This has raised serious concerns among ASEAN policy-makers about the longer term economic development and sustainability of this region.

Against this backdrop, ASEAN leaders agreed to embark on a bold project to integrate their economies and establish an ASEAN Economic Community. This ambitious project will clearly require a significantly higher level of economic integration than that which exists today.

The ASEAN Economic Community

At the 2003 ASEAN Summit in Bali, Indonesia, ASEAN leaders agreed to integrate their economies by 2020 and establish an ASEAN Economic Community (AEC). The AEC is one of the three components or pillars that make up the ASEAN Community as declared by ASEAN leaders in the ASEAN Concord II (better known as the Bali Concord II). At the ASEAN Summit held in Cebu, Philippines in January 2007, the deadline to realize the AEC was brought forward by five years to 2015.

The end-goal of the AEC is the creation of a single market and production base where there is free flow of goods, services, investments, capital, and skilled labour.

Southeast Asia will grow slower in 2005 — at 5 per cent compared with 6.3 per cent observed in the previous year (ADB 2005). The slowdown in the major industrial countries has been a drag on the global economy and high oil prices will continue to be a matter of concern over the coming year.

Global economic growth will decelerate to 4.3 per cent in 2005 compared with a historical high of 5.1 per cent in 2004 (IMF 2005) (Figure 1). World trade volume (goods and services) growth will soften from 10.3 to 7 per cent over the same period. It is evident that high oil prices and the downturn in the information technology (IT) sector have clearly taken their toll on industrial production and world trade in 2005.

Most countries in Southeast Asia will register lower growth rates in gross domestic product (GDP) in 2005 (Figures 2 and 3). The IT slump has affected the export performance of Singapore, Malaysia, the Philippines, and Thailand. On the supply side, bad weather conditions during the year have badly affected agricultural output in the Philippines and Thailand.

Continued high oil prices have clearly dampened economic growth in the region. Oil-dependent countries such as Singapore, Thailand, and the Philippines were particularly vulnerable. Indonesia also fared badly as its huge fuel subsidies were causing a severe downward pressure on the rupiah. Nevertheless, the country's currency has begun to stabilize, with significant hikes in domestic gasoline and diesel prices imposed by the Indonesian government.

Inflows of foreign direct investment (FDI) to China rose from US$53.5 billion in 2003 to US$60.6 billion in 2004, making it the world's third largest destination for FDI after the United States and the United Kingdom (UNCTAD 2005). Meanwhile, Southeast Asia saw a significant rise in FDI inflows, from US$17.4 billion in 2003 to US$25.7 billion in 2004 (Figure 4). The main beneficiaries of the higher inflows were Singapore, Malaysia, Indonesia, Myanmar, Vietnam, Cambodia, and the Philippines.

Introduction

2004 was a very good year for Malaysia. Although the Malaysian economy showed some signs of easing in the fourth quarter of 2004, strong growth in the first three quarters (averaging 7.6 per cent) delivered a robust GDP growth of 7.1 per cent for the full year. (The economy grew 5.3 per cent and 4.1 per cent in 2003 and 2002 respectively.) Although growth prospects appear fairly positive over the next year or two, is Malaysia able to sustain a strong rate of economic growth in the medium to long term?

Malaysia has undoubtedly recovered from the Asian financial crisis of 1997/98 (see Figure 11.1) but the world has changed significantly since then. Besides the US and Japan, China has in recent years become an important engine of growth for the region as well as a major recipient of foreign direct investments (FDI). The world economy has also become increasingly globalised and this poses new challenges for Malaysia. These emerging challenges may affect Malaysia's economic development and overall international competitiveness in the coming years. This chapter aims to identify the key economic challenges that will have an impact on Malaysia's medium- to long-term economic development.

Rising Competition for FDI

FDI inflows to Malaysia have been showing a declining trend in the 1990s. Using UNCTAD's World Investment Report 2004 database, as a percentage of developing countries total, FDI inflows to Malaysia declined from 8.7 per cent in 1992 to 1.4 per cent in 2003. According to the UNCTAD Inward FDI Performance Index, which measures the extent to which host countries receive inward FDI, there has been a sharp deterioration in Malaysia's FDI performance.

This is a worrying trend as Malaysia is dependent on FDI as a driver of growth.

The year 2004 was very good for Southeast Asian economies. The region was well underway towards economic recovery, underpinned by robust growth in the global economy. In 2004, the global economy achieved a growth rate of 5.1 per cent — the highest in three decades — while world trade volume (goods and services) expanded 9.9 per cent. Stronger global growth was driven by economic rebounds in the United States, Japan and the European Union as well as rapid economic expansion in China.

Southeast Asia registered a strong GDP growth rate of 6.3 per cent in 2004 while the whole of East Asia grew by 7.8 per cent. Robust growth in regional economies had been underpinned by strong export performance and continued strengthening of domestic demand.

Singapore, Malaysia and Vietnam were the star performers in 2004. Singapore's economy grew strongly by 8.4 per cent compared to the previous year's lacklustre growth of 1.4 per cent when the city-state was affected by the SARS epidemic. Like Singapore, 2004 was a good year for Malaysia's economy. Although the Malaysian economy showed some signs of easing in the fourth quarter of 2004, strong growth in the first three quarters (averaging 7.6 per cent) delivered a robust GDP growth of 7.1 per cent for the full year. Both countries' economic performance was driven by strong domestic and external demand.

Vietnam's economy grew by a robust 7.5 per cent in 2004 supported by buoyant exports and strong consumer demand. Other Southeast Asian countries such as Thailand and Laos were also expected to report solid GDP growth rates. Table 1 shows real GDP growth rates for the ten member countries of the Association of Southeast Asian Nations (ASEAN) from 2000 to 2004. Figure 1 shows the real GDP quarterly growth for the ASEAN-5 countries (i.e. Indonesia, Malaysia, Philippines, Thailand and Singapore) over the same period.

The favourable external economic environment over the past year led to a rapid expansion of merchandise exports in Southeast Asia with many countries enjoying double-digit growth rates.

Economic recovery in the region is well under way, underpinned by robust growth in the global economy. In 2004, global output is projected to grow by 5 per cent while world trade volume (goods and services) will expand by 8.8 per cent (IMF 2004). Stronger global growth has been driven by economic rebounds in the United States, Japan, and the European Union as well as rapid economic expansion in China.

Southeast Asia is expected to register a strong GDP growth rate of 6.2 per cent in 2004 while the whole of East Asia is expected to grow by 7.3 per cent (ADB 2004). Robust growth in regional economies has been underpinned by increased industrial production in major economies (namely, the United States and Japan), sustained demand from China's booming economy, and an upturn in the information and communication technology (ICT) industry. Merchandise exports are expected to expand by 13.9 per cent in 2004 with many countries projecting double-digit growth rates (ADB 2004).

Singapore, Malaysia, and Vietnam are the region's star performers in terms of economic performance in 2004. Singapore's economy is expected to expand by 8.9 per cent while both Malaysia and Vietnam are projected to grow 7.5 per cent. Other Southeast Asian countries such as Thailand and Laos are also expected to register healthy GDP growth rates. (See country contributions for more detail on the economic projections.)

China continues to receive the lion's share of the world's foreign direct investments (FDI) — the country received US$53.5 billion worth of FDI in 2003 (UNCTAD 2004). In the same year, FDI flows to Southeast Asia increased by 27 per cent to US$19 billion. There continued to be disinvestments in Indonesia although the magnitude was significantly smaller compared with previous years.

Private investment has been picking up in Southeast Asia after several years of contraction or lackluster growth. Progress made in reducing non-performing loans, higher-capacity utilization, low interest rates, and improved business confidence have all contributed to the revival in private investment.

Three key political features of 2003 will continue to mark the regional climate in 2004. They are the U.S. war in Iraq, the spectre of terrorism and leadership changes in a few ASEAN countries.

When the United States asked for support for its war against the Saddam Hussein regime in Iraq, it was evident that ASEAN could not work out a common position on this as there were members who were willing to join the U.S. “coalition of the willing” and others who opposed the U.S. action in no uncertain terms. These differences will continue to be tested as the U.S. action drags on in Iraq.

The fortunate thing is it has not disrupted the common will to fight Islamic terrorist groups operating in the region. Terrorism remains the region's foremost security threat and while it is not acute enough to immobilize any daily routine in the ASEAN countries, it does have serious implications for foreign investors' confidence in the region. Some progress has been made in the bid to arrest key personnel in terrorist groups and disrupt their operations. However, when a bomb went off in Jakarta in August 2003, less than a year after the October 2002 bombing in Bali, everybody is reminded that the spectre of terrorism is very real and can strike anywhere any time. In May 2003, Cambodia with a minority Islamic community of 700,000 joined the list of ASEAN countries that have to take security action against people with connections to Islamic terrorist organizations.

In the midst of these bracing times, three major ASEAN countries — Indonesia, Malaysia and the Philippines — face national elections. In all cases, the incumbents are the favoured candidates to win, thus guaranteeing a measure of continuity. But in two of these three cases — Indonesia and the Philippines — the electoral outcomes are not likely to produce any reliable solution to ineffective governance. The 2003 national election in Cambodia has produced another hung legislature which can only prolong the political disorder of that country.

Southeast Asia suffered a setback on its road to economic recovery in 2003. In the first half of 2003, regional economies were particularly affected by the Iraq War and the Severe Acute Respiratory Syndrome (SARS) outbreak. However, the relatively quick passing of these two major events as well as economic recoveries in the United States and Japan augur well for the region's economic outlook in 2004 and 2005.

According to the Asian Development Bank (ADB), the total economic costs of SARS in East and Southeast Asia are estimated at US$60 billion. The services sector, especially tourism and retail industries, were hardest hit. Nevertheless, the impact of SARS on the region has turned out to be less damaging than earlier anticipated. The epidemic, which broke out in March 2003, was generally contained by mid-2003. In fact, tourist arrivals and retail sales in SARS-affected countries such as Singapore and Hong Kong improved significantly by the third quarter of 2003. Although there are some concerns that SARS may re-occur in the near future, it is expected that the region's public health services would be better prepared to deal with the disease.

The economic outlook appears optimistic, with the region poised for a moderate comeback in 2004. The ADB forecasts that Southeast Asia will grow by 3.9 per cent in 2003 and by 4.9 per cent in 2004. In a recent economic report on East Asia, the World Bank highlighted several reasons for being sanguine, which include:

• The global economy is showing signs of recovery, driven by stronger economic growth from the United States and Japan.

• The world high technology industry is beginning to improve after a three-year slump.

• The emergence of China as a global industrial powerhouse is boosting trade and revitalizing intra-regional production networks in East Asia.

• Domestic economic and financial conditions in the region have significantly improved, e.g., private consumption and investment have strengthened, corporate and banking sectors are healthier.