Economic Diversification (Cambodia)

Economic diversification can positively affect economic growth through two channels; first, through increasing the total factor productivity (Romer 1990), and second; through minimizing risks by enlarging the investment portfolio (Acemoglu and Zilibotti, 1997).

Endogenous growth theory suggests that economic diversification is important in growth. Romer (1990) shows the positive effect of diversification on economic growth, expressed by the availability of inputs that contributed to increased labor productivity. In the endogenous growth theories, diversification is included as an exogenous variable. Thus, it is captured in through total factor productivity. The relationship between growth, productivity, and diversification shows that diversification affects total factor productivity and thus growth (Hammouda et al, 2009). The authors ran regressions in which TFP is a function of diversification, openness, financial deepening, and conflict. Diversification index was calculated through exports, based on UNCTAD and World Development data. The index is between 0 (perfectly diversified) and 1 (very specialized). Three specifications were used. The three models show that an increase in diversification has led to increase in Total Factor Productivity.

There are several ways in which economic diversification can be measured. One way to look at diversification is through number and different economic activities (sectors) in an economy. The higher the number of sectors contributing to the overall growth, the more diversified is the economy. A second way to study investigate economic diversification is through the employment distribution within the different sectors in a given economy. An economy in which, say 80% of workers are employed in one sector is less diversified compared to an economy in which workers are evenly distributed across the sectors. Some researchers also use the variety of exports of a given economy as an indication of a diversified open economy.

Diversification in Cambodia: Cambodias high economic growth up to the 2008 crisis was led by four main sectors; agriculture, clothing, tourism, and construction1. Since then, the issue of narrow economic base has been concerning to the Cambodian government. External forces that concerns Cambodian economy include; the weak external demand for Cambodian goods; increased increasing prices, and; China shifting its comparative advantage to new areas as part of its growth (SNEC, 2011).
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http://www.un.org.kh/undp/4th-cambodia-economic-forum/4th-cambodia-economic-forum

Cambodia development strategy aims at modernizing its economy through developing its industrial sector (CEF 2011). This comes as an effort to mitigate the impact of external shocks on the Cambodian economy, and to lift Cambodian development to a higher stage. Industrial development is crucial for Cambodia since increasing the Total Factor Productivity (TFP) above the current ratio (1%) is likely to increase GDP by higher than 6.2% (associated with 1% TFP). While at the current growth rates Cambodia is likely to become a middle income country in 5-10 years (and upper middle income in 35-40 years), a higher TFP (and thus GDP) is likely to shorten the catch up period significantly. TFP increases with TFP, and thus, Cambodia option for increasing TFP through industrial development of various sectors. Diversification through industrial development is supported in Cambodia by the fact that economic growth in the the last decade occurred through enlargement of the industrial base (SNEC, 2011). Between 1995 and 2010, agriculture portion of the GDP dropped from 45% to 30%, while industry increased from 15% to 30%. However, between 2001 and 2010, sectoral contribution to GDP reveals a different story as the table below shows: Composition of GDP by Sector (%) 2001 2005 2010 Agriculture, Fishery & Forestry 34.3 30.7 33.5 Industry 22.3 25 21.6 Services 33.4 39.1 39.3 Source: compilation from Cambodia Economic Framework (2000-2011) Sectors The data suggest that economic diversification took place between 1995 and 2000, and by 2010 agriculture and industry maintained portions in GDP as they did in 2000.

Another indication of possible diversification is a stagnant labour productivity in the agricultural sector and an increased productivity in the industrial sector, in a rapid economic growth context. The following table shows the changes in labor productivity during the last two decades:

Productivity Ratio Industry vs. Agriculture Services vs. Agriculture Industry vs. Services
Source: SNEC 2011.

1995 6 4 2

2000 9 4 2

2005 9 5 2

2008 9 6 2

The industrial sector shows gains in labour productivity to agriculture and services. However, the productivity growth has stagnated between 2000 and 2008. The increased productivity in the industrial 2

sector is coupled with a doubling in the employment in the sector between 1998 and 2008 as shown in the tablebelow: Table: distribution of Employment by Type of Sector: 2008 Total Urban Rural 1998 Total Urban Rural
Source: NIS (2009)

Primary 72.3% 14.0% 85.0% Primary 77.5% 20.1% 88.2%

Secondary 8.5% 25.3% 4.9% Secondary 4.2% 16.2% 2.0%

Tertiary 19.2% 60.7% 10.1% Tertiary 18.3% 63.7% 9.8%

Total 100% 100% 100% Total 100% 100% 100%

Between 1998 and 2008, employment in the primary sector decreased by 5.2%; Secondary sector employment has increased by 4.3%; Tertiary has increased by 0.9%. The change in the labour composition has not been drastic. However, changes could have happened between industries within the sector.

Diversification Future Direction: While agriculture make 70 percent of country output, garment industry make the bulk of the exports (around 70 percent). The government aims at reducing the dependence on garment industry through giving priority to other labour-intensive and assembly of electronics and electrical appliances. The industrial sector strategy for the country includes: Develop labor intensive industries Develop natural resource-based industries such as fish and meat processing, cement, and tiles Promote industries that produce appliances for industrial use. Quality control system is required to ensure good quality exports of such appliances Establish industrial and export zones that encourage variety of investments; and Promote tourism

FDIs: FDIs investment has increased dramatically in the last two decades. FDI investment in 2009 was 5859 million dollars, compared to 506 million in 1994. The total FDI investment between 1994 and 2008 amounted for 24.768 billion dollars. FDIs in combodia are mainly from ASEAN (54%); China makes around 24% of All FDIs. Chinas FDI in Cambodia was 5.707 billion dollars. Korean FDIs are second, and make 11% of total value 2.749 billion dollars. Major FDIs also come from Malaysia, Taiwan, Hong Kong and Thailand (CDC website).

FDI investment is heavily in the secondary and tertiary sectors, amounting for 22% and 24 % respectively. Between 1994 and 2005 investment was; agriculture 7%; industry 21%; services 20%, and; Tourism 522. The high share in tourism investment reflects the cultural heritage of Cambodia. The tourism sector is supported (and supports) services sector, including the restaurant and hotel businesses. On the other hand, ight industries like garments and textiles attracted FDI in the past since Cambodia is classified among Most Favoured Nation (MFN) in the global trading system, and thus FDIs used the country as a platform to avoid tariffs (and Quotas?) requirement in western economies. Third of inward FDIs in Cambodia are in the garment industry in 2006 (CAS49,pp4). The high FDI inflow in the garment business is related to the cheap abundant labour in the country.

Cambodia Investment Policy, Investment Climate and Cooperation in GMS (2010)

Technological Upgrading in Thailand

Economic growth is linked to industrialization in economics literature. Kaldor (1957) suggested that differences in development stages can be explained by the levels of technology adopted. Gerschenkron (1962) studied technology gaps and showed that laggard economies have great potential to absorb the accumulated knowledge created by technology frontier economies. However, the literature on technology gap and catch-up process of less developed economies advanced in the 1970s. The basic hypothesis was that economic growth is positively affected by technology growth rates. Through using the accumulated technology, lagging economies can reach technological frontiers through a catch-up process. Furthermore, the absorptive capacity is a key for successful catching up ( Gomulka, 1971; Cornwall, 1977; Maddison, 1979; and Abramovitz, 1979)3.

Technological upgrading can enhance productivity, leading to higher growth (Palit, 2006). Productivity is important when costs (labour/setup/ land) in neighbor economies more competitive. FDIs is one way through which technology is incorporated at the firm level. In relation to value chains, technological capabilities and government support are key factors for developing domestic firms to establish themselves at the high end of value chains4. Countries are considered technologically capable (or not) depending on their technological development. Developing countries usually learn through importing technology. Firms in such countries increase their productivity through using indigenous technologies and adapting the imported technologies. The first stage of technological progress is acquiring the know-how, important way of which is through FDIs. This takes place through spill-over effects through the interaction of domestic enterprises with FDIs. However, domestic firms in developing countries have two challenges; to enter the value chains, and to move upward in the chain. This is a result of the capabilities of the domestic firms in terms of learning and upgrading (page 5). The pressure to upgrade put by FDIs on domestic firms (involved with FDIs) depends on the markets those FDIs are serving (or the buying firm in the value chain). If the FDI serves advanced countries, higher upgrading demands are required from domestic firms. On the other hand, if FDIs serve domestic or other developing country markets, lower pressure for upgrading is put on domestic firms.

3 4

Kraemer-Mbula. E, Wamae.W (2010) Innovation and the Development Agenda, OECD, pp 40 Palit, A. (2006) Technology Upgradation through Value Chains: Challenges before BIMSTEC Nations, CSRID, pp 2

Upgrading Framework: Continuous upgrading of technology, information and skills ensures technological progress. Technological development is determined by FDI and domestic technological effort , thus affecting the environment that affects the firm. The environment includes; the macro and policy level conditions; Sciences and Engineering Base, and; factors enhance technological capabilities of firms. At the firm level, firms make use of the environment to upgrade, achieve competitiveness, leading to high growth5.

Figure X: Upgrading Framework:

Source: Foreign Direct Investment: Performance and Attraction, The Case of Thailand (2002)

Thailand wasnt successful in ensuring FDI enhancement of domestic technological capacities to undertake complex R&D (compared to Singapore). Instead, Thailand focus on assembling high technology products. In fact, Thailand was the 8th world largest exporter of high-tech products (UNCTAD, 2003). Thailand expanded its ICT facilities drastically. However, due to the shortage of quality engineers and scientists in Thailand, the ICT deepening has not been accompanied by technological deepening. The quality of the scientific institutions also does not support technological advancement. The lack of sheer
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Foreign Direct Investment: Performance and Attraction, The Case of Thailand (2002), pp 6

qualified manpower hindered acquiring the know-why which is above the know-how in technological development level. Thus, the gap between the use of high-tech assembly (through FDI foreign technology) and generating new technology hinders Thailands aspiration on the upper-ends of the global value chains. Another factor negatively affecting efforts towards the upper end of value chains is the role of R&D at the firm level, which involves implementation of imported technologies, rather than increasing the absorptive capacities that could lead to innovation and upgrading.

Table : Technological & Innovative Indicators Item Firm-level technical absorption Prevalence of tech licensing Innovation Capacity Utility Patent Scientists & Engineers University-Industry Collaboration Corporate R&D Quality of Scientific Institutions FDI & Technology Transfer Rank out of 117 38 16 62 60 69 28 37 41 23

Source: Technology Upgradation through Global Value Chains: Challenges before BIMSTEC Nations (2006)

FDIs in Thailand: Half of the overall investment registered in Thailand is Foreign Direct Investment. Japanese FDI inflow into Thailand accounts for 60% of all inflows in the country. Current Net FDI value (inward less outward) in Thailand was positive between 2000 and 2010. The highest net flow of FDI in Thailand was in 2006, but was lower by more than 50% in 20106. During the 11 years, the total current net flows show that FDIs in machinery and transport equipment sector created the most value (446,910 millions Baht). During the same period, the average annual share of the sector value in total FDI flows is 19% (with highest share 59% in 2009). Electrical appliances, trade, chemicals, finance, are key FDI sectors in Thailand.

By Sector: The manufacturing sector accounts for 80% of all the investments, of which 54% is in machine and transport equipment. 60 percent of approved investments are export oriented manufacturing.

Current net value of FDI is USD is provided in the Annex.

However, FDIs are moving away from mass manufacturing, as a result of cheaper setup and labor costs in neighboring countries such as China and Vietnam. FDIs inflow in Thailand in the mass manufacturing has dropped by 20 percent in the last five years. FDI in Thailand are also declining in chemicals sector due to the presence of strong domestic firms that serve domestic and foreign markets.

Table 2: FDI Share by Sector:

Source: Own calculations based on Bank of Thailand data, 2012

Foreign vs. Domestic Markets: Thailand plans to become a production center for export markets. 60% of approved investment is directed towards exports. In terms of sectors, 90% of registered investments in electric and electronic products are for export purposes, after which come minerals and ceramics with 89%. Light industries and textiles export-oriented investment are estimated at 81%. The most locally demanded FDI production is mainly machinery and metals, and chemicals (including papers). FDIs production serving Thai market is increasing for the various sectors (except for textiles/ light industry, and minerals). On the other hand, manufacturing, by local firms and FDIs, for both domestic and foreign markets in the metals and machinery and metal products sector include that of office machinery, computing, automotive, and electronic parts.

By Country: Bank of Thailand records show that FDIs in Thailand come from at least 53 countries. During the period, 2005-2010, Japanese FDIs in Thailand represented almost one third of all FDIs in the country. During the same period, ASEAN FDIs in Thailand accounted for 20.9% of all FDIs, of which Singapore accounted for 17.3%. EU FDIs in Thailand make 15% of the total, with Netherlands accounting for one third of EU FDIs. Chinese FDI in Thailand makes 4% of all FDIs. Japanese FDIs in Thailand produce electronics, textiles and transport machinery. On the other hand Japanese outsourcing in Thailand is likely to be in the medium-end functions that need less technical skills (compared to high value-added production) which Thai domestic firms possess.

Annex 1: Cambodia GDP by Sector Share (%)

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Annex 2: Thailand Development Stages

Source: Thailand Economic Outlook 2011

Annex3: Thailand FDI Net Flow

Source: Bank of Thailand, 2012

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Source: Bank of Thailand

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Annex 4: FDI Classified by Country (Millions of Dollars)

Source: Bank of Thailand, 2012

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