Economic Freedom and the Asian Century

So many facets of the “Asian century” are discussed heatedly. But one is glossed over — economic freedom. Market liberalisation is a crucial enabler of Asia’s current awakening. Its “negative” acts – removing restrictions that repress economic activity – have 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 will be vital to the progress of the Asian Century. This should be the leitmotif for public policy and governance.

Start with historical lessons. First, for most of the past millennium, Asia had predatory states that suppressed individual freedom and enterprise; and they were inward-looking. Recent avatars were China under Mao, India’s licence raj, and Indonesia under Soekarno. These gross errors should obviously not be repeated. Second, Asia should emulate the factors behind the West’s ascent during the past millennium: institutions to support individualism, competition and enterprise in market society; and openness to international trade, especially in the nineteenth century.

 

Third, Asia can reconnect to a golden age of commerce – Indian Ocean and southeast-Asian trade before Western colonialism. Trade flourished among “port-polities” like Cambay, Calicut, Malacca and Macassar – the precursors of modern-day Hong Kong and Singapore. Their rulers encouraged enterprise and overseas trade with light-touch regulation and very little protectionism. They also fostered religious tolerance and cosmopolitan societies. This plus the freedom of the seas enabled trading diasporas to knit Asia together through commerce.

 

Fourth, the key lesson of the “East Asian miracle” of recent decades is to “get the basics right”: prudent monetary and fiscal policies, competitive exchange rates, low domestic distortions (such as price controls), openness to international trade, and investments in education and infrastructure. The alleged success of “industrial policies” — selective interventions to promote targeted sectors — is highly debatable. Indeed there is little hard evidence – only assertion – that they worked.

 

Now turn to key planks of contemporary policy.

 

First, financial-market policies. 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 in 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 – though this has to be balanced with prudential controls to reduce vulnerability to extreme external shocks.

 

Furthermore, “financial repression” is at the core of “unbalanced growth” in several Asian economies – 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. Carefully managed financial liberalisation would liberate domestic private-sector growth, especially in services.

 

Second, trade and foreign-investment policies. In Asia, trade and 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.

 

Third, energy and environmental policies. Energy consumption in developing Asia is expected to double over the next two decades. That translates into much more demand for fossil fuels – oil, natural gas and coal. China and India will import much more of all three, especially oil and natural gas, for which they will become even more reliant on the Middle East. 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 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-sector 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 carbon emissions sooner or later. Given the targets set, for example by the Stern and Garnaut Reports, that will inevitably lower growth potential. Here scepticism is in order. Climate science is not “settled”, contrary to the conventional wisdom. It, and much of the economics that flows from it, do not take adequate account of long-range uncertainty. And many of the proposals contained in heavy-hitting economic studies – on targets, 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 mitigation.

 

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. That will provide the right environment for mobilising savings and investment, labour and capital, for growth. Asia’s middle and high-income economies should focus on “second-generation” reforms – more complex structural reforms in the thickets of domestic regulation – to boost competition, innovation and productivity gains.

 

Both first and second-generation reforms entail the expansion of economic freedom. The former do not require deep reforms in underlying economic institutions; catch-up growth depends more on getting the policy basics right, which spurs a measure of institutional reform. But structural reforms demand deeper institutional reforms in order to deliver productivity-led growth. Otherwise catch-up growth tapers off and countries get stuck in a “middle-income trap”.

 

Finally, 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 straightjacketed, 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.

 

Disclaimer: ‘Economic Freedom in the Asian Century’ is a Guest Article. The views expressed in this article are strictly the author’s own and do not necessarily reflect those of the editor of the ‘Talking Economics’ blog or the Institute of Policy Studies. Any queries can be directed to talkingeconomics@ips.lk