Growth Horizons for a Changing Asian Regional Economy

8/12/2019 Growth Horizons for a Changing Asian Regional Economy

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ASIAN DEVELOPMENT BANK

GROWTH HORIZONSFOR A CHANGINGASIAN REGIONAL ECONOMYDavid Roland-Holst and Guntur Sugiyarto

ADB ECONOMICSWORKING PAPER SERIES

NO.

March


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ADB Economics Working Paper Series

Growth Horizons for a ChangingAsian Regional Economy

David Roland-Holst and Guntur Sugiyarto

No. | March

David Roland-Holst is a professor of economics atthe University of California (UC) Berkeley. GunturSugiyarto is a senior economist in the Economics andResearch Department of the Asian Development Bank.

ASIAN DEVELOPMENT BANK


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Asian Development Bank ADB Avenue, Mandaluyong City

Metro Manila, Philippineswww.adb.org

by Asian Development BankMarch ISSN -Publication Stock No. WPS

The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the AsianDevelopment Bank (ADB) or its Board of Governors or the governments they represent.

ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for anyconsequence of their use.

By making any designation of or reference to a particular territory or geographic area, or by using the term country in thisdocument, ADB does not intend to make any judgments as to the legal or other status of any territory or area.

Note: In this publication, refers to US dollars.

The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedbackon ongoing and recently completed research and policy studies undertaken by the Asian

Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economicand development problems, particularly those facing the Asia and Pacific region; as well asconceptual, analytical, or methodological issues relating to project/program economic analysis, andstatistical data and measurement. The series aims to enhance the knowledge on Asias developmentand policy challenges; strengthen analytical rigor and quality of ADBs country partnership strategies,and its subregional and country operations; and improve the quality and availability of statistical dataand development indicators for monitoring development effectiveness.

The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titlescould subsequently be revised for publication as articles in professional journals or chapters in books.The series is maintained by the Economics and Research Department.


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CONTENTS

ABSTRACT v

I. INTRODUCTION

II. MODELING FRAMEWORK

III. BASELINE AND POLICY SCENARIOS

A. Productivity Scenarios B. Policy Scenarios

IV. MACROECONOMIC RESULTS

A. Real Gross Domestic Product Growth B. Gross Domestic Product Components and Welfare Impacts

V. MODERNIZATION AND CHANGING ECONOMIC STRUCTURE

A. Agriculture and Food Sectors

VI. LABOR MARKET IMPACTS

A. Wages B. Employment

VII. CONCLUSION AND POLICY IMPLICATIONS

APPENDIX: TECHNICAL OVERVIEW OF THE TRADE INTEGRATED GENERALEQUILIBRIUM (TIGER) MODEL

A. Production B. Consumption and Closure Rules C. Foreign Trade D. Prices E. Elasticities F. Model Calibration

G. Notes on the Adjustment Process REFERENCES


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ABSTRACT

After two generations of economic growth, the next phase of structural transformation

for Asia will have several salient features. Our results suggest that no single policyorientation, pathway, or even destination will apply to all economies. The main driverfor each economys structural change will be demand, both domestic and external.These demand sources can have very different sector emphasis, however, and drivedomestic resource allocation in different directions. Asian economies with high exportshares will be drawn to more intensive primary and industrial resource allocation, whilethose with larger domestic demand shares will become more service-oriented. Ourlong-term forecasts for the Asian economies suggest that factor productivity growthcontinues to be essential to improving livelihoods generally and promoting regionalconvergence in particular. Of particular importance is potential for reducing regionalinequality through more inclusive growthproductivity improvements are more cost-effective in lower-income countries and they have a bigger relative income dividend.Our research also reveals that services are essential contributors to average livingstandards in high-, medium-, and even low-income Asian economies. For this reason,policies that improve the efficiency of service sector labor allocation, as well as skill andproductivity improvements via determined education and training programs, will beessential to sustaining higher living standards and transition to long-term growthsustained by demand from an ever-expanding middle class.

Keywords: structural transformation, factor productivity, Asian financial integration,service sector

JEL Classification: C , C , E , F , F , O


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I. INTRODUCTION

Two generations of sustained growth have transformed the Asian regional economies, makpervasive contributions to improved living standards and changing Asias relationship to the geconomy. As this economic transition matures, structural adjustment will continue in the mdeveloped ADB member countries (AMCs) and opportunities for growth-oriented structural chain the developing member countries (DMCs) will proliferate. The prospects for sustaining expanding this regional dynamism are very bright, but they need to be supported by determdomestic and multilateral commitments to productivity growth and regional economic integraFortunately, the region can draw upon policy lessons from two generations of successfully imprliving standards and modernization.

To strengthen the basis of evidence for regional policy making, this study presents a selong-term forecasts for Asian regional growth, highlighting the roles of factor productivity and pthat can facilitate private sector support for more sustained and inclusive regional growth. Ascomprised of very diverse economies, and this diversity presents both challenges and opportunChallenges include institutional differences that can undermine regional policy coherence and esc

both costs and risks for regional investors. Also impeding growth are limited domestic saresources in lower-income DMCs, which hinder investment and technological progress. Anoconstraint from the same source is limited fiscal capacity, which leads to very different levels ocapita public goods and services across the region.

On the positive side, economic diversity presents many opportunities for more efficiregional specialization. Faster-growing economies can confer growth externalities upon their neigand countries with relatively abundant low-cost resources (including labor) can offer higher and diversified investment returns to countries with relatively abundant capital resources and madvanced commercial institutional development. Conversely, countries with high net savingsfacilitate growth by investing in savings-constrained DMCs, supporting higher employmtechnology transfer, and export market access for their partners.

Long-term forecasts for the Asian economies suggest that factor productivity growcontinues to be essential to improving livelihoods generally and promoting regional convergenparticular. Our findings support the notion that productivity improvements are not only more ceffective in lower-income countries, they have a bigger relative income dividend for recipient thainvesting countries. Looking at a variety of policies that facilitate productivity growth by promprivate sector development, our results offer three main insights. First, the potential benefits of furegional tariff reductions are limited, and Asian economies should expand their trade policy dialaddress more structural barriers to trade. Second, trade-facilitating investments in hard infrastruccan significantly enhance growth in the region, particularly for lower-income economies.

Finally, the biggest growth dividend we have identified comes from deeper Asian finaintegration. In the past, successful Asian economies have been technology driven and continustriving to upgrade the skills of their population. The benefits of this human resources approacgrowth and development become even more pronounced with the application of regional policiesfacilitate trade and capital flows. With more effective Asian regional integration, including muchefficient regional capital allocation, Asias prosperity can accelerate significantly and reach out majority of its population, over half of humanity. This second, and perhaps greatest, stage of moAsian economic emergence, growth through regionalism, could make the greatest contributiolivelihood improvement in modern times.


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| ADB Economics Working Paper Series No.

II. MODELING FRAMEWORK

The research reported here is based on application of a multicountry dynamic model that captudetailed trade and domestic market interactions between and within Asia and in its relationship torest of the world. Generally speaking, the complexities of todays global economy make it very uthat policymakers relying on intuition or rules-of-thumb will achieve anything approaching optiin either the domestic or international arenas. Market interactions are so pervasive in determieconomic outcomes that more sophisticated empirical research tools are needed to improve visibfor both public and private sector decision makers.

The preferred tool for detailed empirical analysis of economic policy is now the calibrgeneral equilibrium (CGE) model. It is well suited to growth analysis because it can detail struadjustments within national economies and elucidate their interactions in international markets. model, based on a prototype global trade model developed by the World Bank, is technicsummarized in the Appendix and fully documented elsewhere (Roland-Holst and Sugiyarto 1 Forthe present discussion, a few general comments will facilitate interpretation of the scenario resultsfollow.

Models, like the one used here are intended to capture the extended linkages and indireffects that follow from specific policies and external shocks. The complexities of todays geconomy make it very unlikely that policymakers relying on intuition or rules-of-thumb will aoptimality. Market interactions are so pervasive in determining economic outcomes that msophisticated empirical research tools are needed to improve visibility for both public and prsector decision makers.

Technically, a CGE model is a system of simultaneous equations that simulate price-direcinteractions between firms and households in commodity and factor markets. The rolesgovernment, capital markets, and other trading partners are also specified, with varying degredetail and passivity, to close the model and account for economywide resource allocation, producand income determination.

The role of markets is to mediate exchange, usually with a flexible system of prices, the important endogenous variables in a typical CGE model. As in a real market economy, commodifactor price changes induce changes in the level and composition of supply and demand, producand income, and the remaining endogenous variables in the system. In CGE models, an equsystem is solved for prices that correspond to equilibrium in markets and satisfy the accounidentities governing economic behavior. If such a system is precisely specified, equilibrium aexists and such a consistent model can be calibrated to a base period data set. The resulting calibrgeneral equilibrium model is then used to simulate the economywide (and regional) effectalternative policies or external events.

The distinguishing feature of a general equilibrium model, applied or theoretical, is its cform specification of all activities in the economic system under study. This can be contrasted more traditional partial equilibrium analysis, where linkages to other domestic markets and agendeliberately excluded from consideration. A large and growing body of evidence suggests that ineffects (e.g., upstream and downstream production linkages) arising from policy changes are notsubstantial, but may in some cases even outweigh direct effects. Only a model that consiste

1 Roland-Holst and Sugiyarto .


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Growth Horizons for a Changing Asian Regional Economy|

specifies economywide interactions can fully assess the implications of economic policies or bustrategies. In a multicountry model like the one used in this study, indirect effects include the tlinkages between countries and regions which themselves can have policy implications.

III. BASELINE AND POLICY SCENARIOS

The starting point for this Asian regional trade analysis is a global trade database for , whextrapolate forward to with a dynamic CGE model.2 The extrapolation is carried out as a dynamiccalibration to baseline aggregate growth forecasting obtained from growth accounting exercisescalibrated baseline then serves as a reference point to evaluate policy scenarios and othcounterfactual events, but it is also of independent interest as an indicator of changing long-teconomic conditions. In this section, we review some of the economic fundamentals from the basprojection and compare them with scenarios for alternative trade regimes and changing conditionregional trade and transport.

Figure presents the average forecasted growth rates for Asian economies over the perio

analysis. In this figure, we use a league table layout to highlight the ranking of per capitadomestic product (GDP) growth rates and the effect of population growth on per capita real incomNote that we do not take account of purchasing power parity or shifts in nominal exchange ratethese results are subject to some qualification. In our baseline, the main characteristics of Asian grare expected to persist in a relatively stable regional and global policy environment. We also assume no exogenous shocks (SARs, tsunami, avian flu, recession, etc.) are of sufficient magnituderail baseline growth more than temporarily.

Having made these caveats, we see that because of its economic momentum (growth timabsolute size), the Peoples Republic of China (PRC) is expected to continue providing grleadership in the region. For other economies, improvements in real living standards will depend interaction between growth in real economic activity and in population. Bangladesh, India, Malthe Philippines, Viet Nam, and other economies will all experience significant per capita indiscounts because of high population growth, while high-income Asia will actually experience per capita income because of shrinking populations.

While GDP trends over the baseline are calibrated from independent forecasting estimatstructural adjustments within the regional economies are projected by our dynamic CGE model. Ashall see in the detailed results, beneath the smooth veneer of aggregate Asian growth there wipervasive structural adjustments. These include shifting industrial structure, employment, and tpatterns, all of which must evolve as Asia takes fuller advantage of its expanding and maturing inmarket.

2 See comments and references in the Appendix for more about the data source and model specification.


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Figure : Real Gross Domestic Product Growth by Country and Region (baseline, annualized change)

DMC developing member country, GdpPC per capita gross domestic product, HiInc Asia high-income ADB members, Lao PDRPeoples Democratic Republic, PRC Peoples Republic of China, Pop population.

Sources: International Monetary Fund ( ), and the World Bank ( ).

The baseline is a status quo or business-as-usual scenario where national and multilatpolicy regimes are assumed unchanged and no external shocks occur. Under these conditions, steaggregate growth and moderate structural change are to be expected, yet modern history of the Aregion has been much more dynamic. The difference has been due to a combination of public private agency, with the former providing reformist guidance and the latter responding quickchanging opportunities and challenges. To capture these events in a forecasting framework, we spcounterfactual policy scenarios we are interested in, using simulation analysis to predict how pactors across the region will respond according to the economic theory embodied in the CGE mod

To examine how national and regional policy initiative can advance and expand long-tAsian prosperity, we consider six generic policy scenarios, summarized in Table . These fall ingeneral categories, productivity improvements and private sector promotion, discussed in gredetail below.

Other DMCs

Bangladesh

Cambodia

PRC

India

Indonesia

Kazakhstan

Lao PDR

Malaysia

Pakistan

Philippines

Sri Lanka

Thailand

Viet Nam

HiInc Asia

GdpPC Pop

Middle Income

Low Income

High Income

Other Income


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Table : Policy Scenarios

Scenario Name Description Capital Productivity

GrowthAssume that the Asian economies sustain growth rates of capital productivity asindicated in Figure , with rates for all countries converging to the regional average b

.

Labor ProductivityGrowth Assume that the Asian economies sustain growth rates of labor productivity asindicated in Figure , with rates for all countries converging to the regional average b.

Total FactorProductivity Growth

Assume that the Asian economies sustain growth rates of total factor productivity asindicated in Figure , with rates for all countries converging to the regional average b

. Trade Liberalization In addition to Scenario , assume that Asia achieves abolition of nominal trade

distortions (import taxes and subsidies) across the region Infrastructure

InvestmentIn addition to Scenario , assume that investments and institutional changes effect a

reduction in trade, transport, and transit margins for lower-income Asiancountries.

Asian FinancialIntegration

In addition to Scenario , assume that, for developing member countries, the stock oforeign direct investment rises to at least of gross domestic product by .

Source: Authors framework.

Figure : Factor Productivity Growth in Asia, ( per annum)

DMC developing member country, HiInc high-income ADB members, Lao PDR Lao Peoples Democratic Republic,PRC Peoples Republic of China.

Sources: International Monetary Fund ( ), and the World Bank ( ).

. . . . . . . . . .

Other DMCs

Bangladesh

Cambodia

Philippines

Indonesia

Thailand

Pakistan

Lao PDR

Sri Lanka

Malaysia

Kazakhstan

Viet Nam

India

PRC

HiInc Asia

Capital Labor

Middle Income

Low Income

High Income

Other Income


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A. Productivity Scenarios

One of the hallmarks of Asias modern growth experience has been technological progress anddevelopment. The most dynamic regional economies have all promoted productivity groeffectively, achieving some of the worlds highest rates of total factor productivity growth (FiguCapital productivity was generally advanced through publicprivate partnerships for indumodernization and technology transfer. At the same time, the most dynamic economies intensiand extended their early commitments to education and promotion of skill-intensive employment,in manufacturing and eventually in higher value-added service sectors. The product of these stratein the most successful cases, has been a dramatic expansion of the middle classes, with their attencapacity for self-sustaining domestic growth and expanding public goods and services.

To see the potential for expanding this growth dynamic around the region, our first thscenarios assume that Asian economies stay on their pre-recession trajectories of productivity groThese are relatively high by historical standards, but we assume they reflect an underlying pdetermination to more fully realize the regions vast economic potential. We also assume that lterm growth disparities decline, and in these scenarios all national productivity levels are assum

converge linearly to regional averages by .Finally, we decompose total factor productivity growth in the first two scenarios, attribu

capital productivity growth to technological change and labor productivity growth to the usual sources (education, training, technology). Note that capital productivity includes total facproductivity growth attributable to land.3

B. Policy Scenarios

As has already been observed, the most successful Asian growth economies may be divgeographically, demographically, and even structurally, but they share a domestic legacy of effepublicprivate partnership that has secured their rapid and sustained growth. Indeed, to a signifextent the potential for all of Asia to advance may depend on its ability to extend these institutimodels more widely and deeply across the region. To assess the potential for promoting private sdevelopment in a regional context, we consider three generic policy scenarios.

Trade liberalization. Successive rounds of World Trade Organization negotiations, combinewith an alphabet soup of regional trading agreements, have achieved dramatic expansion of gtrade and accelerated economic growth in most countries.4 In Asia, this linkage has been dramaticallypositive, with the most prosperous economies being the most trade-intensive. This experiesuggests that further trade liberalization could unlock more growth potential across the region. Foreason, we wanted to include a policy scenario for regional trade liberalization. Unfortunately, redata on trade barriers is generally confined to tariff collections, but by this measure Asian econo

are relatively open, with quite low national average real tariff rates. Despite this limitation, wconsider one scenario (trade liberalization) where the ADB member economies remove tariff bar

3 The productivity estimates we use were gleaned from vast literature on growth accounting, beginning with the swork of Solow and Barro and extended by hundreds of authors. Our own results are a synthesis of official and acaestimates.

4 The composition of these trade-induced growth impacts can be controversial, but there is a strong consensus that tand aggregate growth are strongly linked. See, for example, Aghion and Howitt ( ), Dollar and Kraay (Bardhan ( ).


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Figure : Real Gross Domestic Product by Country( change from baseline in )

DMC developing member country, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic,PRC Peoples Republic of China.

Note: Countries/regions are listed in order of increasing per capita income.

Source: Authors estimates.

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h

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S r i L a n

k a

T h a i

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V i e t

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A s i a

( )

Capital Productivity Growth

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Labor Productivity Growth

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Total Factor Productivity

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( )

Trade Liberalization

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Infrastructure Investment

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( )

Asian Financial Integration


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A. Real Gross Domestic Product Growth

The most important macroeconomic findings for each scenario can be summarized as follows:

Improvements in production technology . For most ADB member countries, capital is thebinding constraint on rapid economic growth. For this reason, improvements in production technoas reflected in capital productivity growth, have a significant impact on regional and country-spgrowth prospects. In nearly every country, capital productivity contributes more than laproductivity to aggregate growth, the only exceptions being Bangladesh, whose exports are espelabor intensive, and high-income economies, which are relatively capital abundant. Clearly, sustcommitments to technological change in the region can support higher growth rates, averaging n

higher real GDP by and or more for several countries.

Improvements in labor productivity. In many ways, labor has been the original source ofcomparative advantage for dynamic Asian economies. This is still true in the region, even thoughbecome much more capital intensive because of high accumulated domestic and external savings FDI). Indeed, labor productivity growth in the most capital-intensive economies (high-income As

essential because labor represents such a large share of value added in these economies. Thus, ethough capital constrained economies are more numerous in Asia, the labor component of facproductivity remains more essential for the region as a whole. The essential policy implication ofthat no single productivity policy will fit every case. Lower-income economies need technolochange as a first priority, labor productivity second. Higher-income countries need to make lproductivity a higher priority. One exception again is Bangladesh, whose reliance on labor-inteexports increases the importance of policies that can improve labor productivity.

Total factor productivity growth. This scenario combines the last two, and here we get a realsense of how potent productivity can be as a growth catalyst. If the region can merely sustain thedecades total factor productivity trends, real GDP for Asia as a whole would be nearly hig

and many countries would see improvements exceeding .

Trade liberalization. It has long been understood that, despite their appeal from a politicaeconomy perspective, import tariffs are price distortions that reduce economic efficiency undermine aggregate growth potential. Thus the results of this scenario are consistent with intu(i.e., generally positive), but the gains vary significantly according to initial conditions. Forcountries with relatively high tariff protection or who export toward protected markets, growth from regional tariff reduction can be considerable. Only high-income Asian economies experiensmall adverse impact, the result of moderate regional trade diversion, but this would be more offset by any of the other policies considered. For the region as a whole, however, gains from futariff reduction appear relatively negligible, suggesting that nontariff barriers might be a higher pfor future negotiations to open and more fully integrate regional markets.

Infrastructure investment . The results of Tables and indicate that regional infrastructurimprovements can make significant contributions to long-term Asian growth, particularly thoselimited initial infrastructure. Figure illustrates the sharp regional disparities in existing infrastructure, and regional commitments to improve this would benefit all countries, but especlower-income developing member countries (DMCs).


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Table : Real Gross Domestic Product by Country( change from baseline in )

Country/Region KProd LProd TProd TLib Infr FLib

High Income HiInc Asia Middle Income China, Peoples Rep. of

India Indonesia Kazakhstan Lao PDR Malaysia Pakistan Philippines Sri Lanka Thailand Viet Nam

Low Income Bangladesh Cambodia

Other income Other DMCs

All Asia DMC developing member country, FLib financial liberalization, HiInc Asia high-income ADB members, Infr infrastructure inKProd improvements in production technology, LProd improvements in labor productivity, Lao PDR Lao Peoples Democratic TLib trade liberalization, TProd total factor productivity growth. Note: Countries/regions are listed in order of increasing per capita income.


Table : Real Gross Domestic Product by Country(cumulative difference from baseline, , billions)


High Income HiInc Asia , , , , , Middle Income China, Peoples Rep. of , , , , ,

India , , , ,Indonesia Kazakhstan Lao PDR Malaysia Pakistan Philippines Sri Lanka Thailand Viet Nam

Low Income Bangladesh

Cambodia Other income Other DMCs All Asia , , , , , ,

DMC developing member country, FLib financial liberalization, HiInc Asia high-income ADB members, Infr infrastructure inKProd improvements in production technology, LProd improvements in labor productivity, Lao PDR Lao Peoples Democratic TLib trade liberalization, TProd total factor productivity growth. Note: Countries/regions are listed in order of increasing per capita income.



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Figure : Aggregate National Indexes of Infrastructure Resources

GDP gross domestic product, Inf infrastructure, Pop population, Wgtd weighted population,PRC Peoples Republic of China.

Source: Calderon and Serven ( ).

Regional financial liberalization. More intensive use of FDI within Asia would sharplyincrease long-term growth prospects in the region. More extensive Asian FDI significantly incrreal growth rates, particularly in lower-income DMCs, in some cases more than doubling the benetotal factor productivity growth. Overall, they contributed about trillion to regional real Clearly, more open and extensive regional allocation of investment resources can be a potent catfor growth, particularly in lower-income countries where domestic savings are a serious constradevelopment.

B. Gross Domestic Product Components and Welfare Impacts

Tables give more detailed macroeconomic results for six productivity and policy scenarios. help to elucidate both the actual welfare impacts and the structural adjustments that regioneconomies might experience under each counterfactual. For example, real GDP benefits discuabove actually understate welfare gains to Asian households, more accurately reflected in equivalent variation income effects of the last column. Households gain primarily because of average wages, shifting value added in the direction of workers and final consumption. Althconsumption price indexes (CPIs) usually increase because of enhanced growth against an establiresource base, productivity growth and more liberal multilateral policies income opportunities than offset this. Significantly, if not surprisingly, trade volumes increase sharply for member coufurther accelerating regional integration and real income growth.

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S i n g a p o r e

L o g

I n f r a s t r u c t u r e

I n d e x

Inf Index

GDP Weighted Average Pop Weighted


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Table : Technological Progress, Macroeconomic Impacts ( change from baseline in )

Country/Region GDP Output Exports Imports Cons CPI EV Inc




Other income Other DMCs

All Asia CPI consumer price index, Cons consumption, DMC developing member country, EV Inc equivalent variation in income, FLifinancial liberalization, GDP gross domestic product, HiInc Asia high-income ADB members, Infr infrastructure investment, Kimprovements in production technology, LProd improvements in labor productivity, Lao PDR Lao Peoples Democratic Republictrade liberalization, TProd total factor productivity growth. Note: Countries/regions are listed in order of increasing per capita income.


Table : Labor Productivity Growth, Macroeconomic Impacts( change from baseline in )

Country/Region GDP Output Exports Imports Cons CPI EV IncHigh Income HiInc Asia Middle Income China, Peoples Rep. of


Low Income Bangladesh Cambodia Other income Other DMCs All Asia

Cons consumption, CPI consumer price index, DMC developing member country, EV Inc equivalent variation in income, GDdomestic product, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic.

Note: Countries/regions are listed in order of increasing per capita income. Source: Authors estimates.


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Table : Total Factor Productivity Growth, Macroeconomic Impacts( change from baseline in )





Other income Other DMCs All Asia Cons consumption, CPI consumer price index, DMC developing member country, EV Inc equivalent variation in income, GDdomestic product, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic.Note: Countries/regions are listed in order of increasing per capita income.Source: Authors estimates.

Table : Trade Liberalization( change from baseline in )





Cons consumption, CPI consumer price index, DMC developing member country, EV Inc equivalent variation in income, GDdomestic product, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic.Note: Countries/regions are listed in order of increasing per capita income.Source: Authors estimates.


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Table : Infrastructure Development( change from baseline in )





Other income Other DMCs All Asia Cons consumption, CPI consumer price index, DMC developing member country, EV Inc equivalent variation in income GDdomestic product, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic.Note: Countries/regions are listed in order of increasing per capita income.Source: Authors estimates.

Table : Asian Financial Integration( change from baseline in )





Cons consumption, CPI consumer price index, DMC developing member country, EV Inc equivalent variation in income GDdomestic product, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic.Note: Countries/regions are listed in order of increasing per capita income.Source: Authors estimates.


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All three productivity scenarios have analogous structural implications, but some differeemerge because of different initial relative abundance of factors. In countries with substantial unslabor populations, capital productivity growth induces higher labor productivity indirectly, leadhigher household income effects than direct labor productivity enhancement. In the case of countwith a greater proportion of skilled workers, this effect is attenuated by diminishing returns (econolike high-income Asia are already capital-intensive), and indirect labor gains from capital produdevelopment are smaller than direct benefits of labor productivity improvements.

As is apparent in Table , the GDP component impacts of combined factor productivgrowth are nearly additive. The reason for this is in microeconomic theory. More than additive earise from factor complementarity, where one factors productivity enhances that of another. mentioned above, skilled labor is generally a complement for technology or more advanced cgoods. By contrast, productivity interactions can be less than additive if factors are substitutes, often the case with unskilled labor and technology (the automation problem). In any case, acrothree scenarios the simple message is that productivity is good for growth, regardless of its soDifferent countries, however, could optimize productivity policy by preferentially targeting diffactors.

The results in Tables and show more clearly how trade facilitation via reduced tariff baand infrastructure development can promote regional integration and with it more rapid and sustaAsian growth. In addition to the GDP results, dramatic increases in national exports and imports that reduced trade and transport margins can be a potent catalyst for wider economic participatpromoting private, individual agency as a means of poverty alleviation and more rapid growth athe poorest regional economies. These results elucidate the role of trade policy and infrastructureway to stimulate demand, as a means of reducing trade costs, and as agents of productivity growth

Policy complementarity is also plainly evident in the financial liberalization results of Tawhere we see very strong growth across the entire region and generally more so among lower-incmore saving-constrained economies. FDI is of course only a temporary income transfer, but it is importantly an agent for productive investment, technology transfer, and access to expopportunities. All three of these features act in synergy with domestic resources, especially thoseare relatively abundant and low cost in comparison to the country of investment origin. For this rereallocation of Asian financial reserves from lower-growth, high-income economies can be expto yield higher absolute returns, returns that can benefit both the investors and those in the destinacountries. It remains an ironic fact that some of the destination countries of the last great raceemerging market investment ( ) are now in a position to join the other side of this pyet they have left large financial reserves at the starting gate.

In any case, increasing the depth and scope of Asian FDI should be a high priority for regpolicymakers, particularly in an era of global growth uncertainty. Taken together, Asian economi

no longer small relative to their historical destination markets, and it is not realistic to expectgrowth rates via rapid expansion of domestic market share in slow-growing Organisation for EcoCo-operation and Development (OECD) economies. For this reason, Asia represents a logical soof investment diversification for itself not only for the usual portfolio risk reduction benefitsbecause the region represents most of the worlds superior national growth rates already.6

6 See Roland-Holst and Weiss ( , ); and Roland-Holst et al. ( ) for extensions of these arguments.


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Figure : Agrifood Output Changes( change from baseline in )

DMC developing member country, HiInc Asia high-income ADB members, PDR Lao Peoples Democratic Republic,PRC Peoples Republic of China.


Figure : Share of Gross Domestic Product in Agriculture,

DMC developing member country, GDP gross domestic product, HiInc Asia high-income ADB members, Lao PDR Lao PeopDemocratic Republic, PRC Peoples Republic of China.

Notes: Countries/regions are listed in order of increasing per capita income. Horizontal axis depicts annual per capita real GDP. Bubblproportional to population.

Source: Authors estimates from Global Trade Analysis Project based at Purdue University.

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The perspective of Figure , showing rates of national agricultural growth, understates theof structural transformation in Asia. As Figure makes clear, size matters a great deal in this prThus, the low rates of agricultural growth in the PRC are of much greater significance than agricultural output increases in other DMCs or Malaysia. Indeed, we can see here that the momenof Asian agrarian transition is being driven by the PRC, with India leading a cluster of econommore gradual transition.

Figure clearly illustrates why transition from agriculture is necessary to improve averagestandards. The solid circles in this figure depict agricultural GDP shares in each country, whihollow circles indicate employment shares. Generally, the lower the countrys income, the loweaverage wages in agriculture, historically the economys lowest productivity sector. Food is obvessential for national survival, but in Asia most economies are realizing low average per capitafrom this activity, and net labor migration elsewhere could unlock significant livelihood potential.

Output growth results for manufacturing are more robust and diverse across the region (Fig). As explained earlier, manufacturing is generally a beneficiary of structural transformation ov

period , and in most cases we see resource diversion from and relatively faster grow

agriculture. These results reveal the core of the structural growth dynamic in all six scenaEnhancing the growth potential for Asia will accelerate the structural transition of member econofrom agrarian to industrial, and the countries that go farthest in this structural transformation wthose that grow fastest. As it did for earlier generations of dynamic Asian economies, industrialiwill be the main engine of employment and income growth. Our results suggest that all the econoof the region can enhance this source of growth, but that some need more determined and perhatargeted industrial policies than others.

Figure : Gross Domestic Product and Employment Shares in Agriculture,

DMC developing member country, GDP gross domestic product, HiInc Asia high-income ADB members, Lao PDR Lao PeopDemocratic Republic, PRC Peoples Republic of China.

Notes: Countries/regions are listed in order of increasing per capita income. Solid circles depict agricultural GDP shares in each countthe hollow circles indicate employment shares. Horizontal axis depicts annual per capita real GDP. Bubble size is proportional to popu


Other DMCs

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( )

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Figure : Manufacturing Output Changes( change from baseline in )

DMC developing member country, HiInc Asia high-income ADB members, Lao PDR People Democratic Republic,PRC Peoples Republic of China.


A scale-adjusted perspective on regional economic structure is presented in Figure , w

more explicitly reveals the transformational nature of manufacturing. Using heuristic dividing lirepresent the three stages of structural transformation, we see how the PRC has emerged as the mindustry-intensive economy (in GDP terms) in the region. The impacts of this on domestic lstandards are well known, as industrial employment was fueled by migration of subsistence wagpopulations, the resulting income growth has been very dramatic. Figure reminds us that the labor reserves exist in India (in both rural and urban areas), but the challenge remains to stimlarge-scale industrial employment and recruit these populations into the process of structutransformation.

Comparing GDP and employment shares (Figure ) shows that manufacturing has mpotential to contribute to average living standards. In the PRC, GDP shares for industry are signifhigher than employment shares, indicating that secondary economic structure is an important drivrising living standards. In India, by contrast, industry contributes less to total GDP than to employsuggesting that manufacturing wages lag service compensation in contributing to average per cincomes. This is also true of high-income Asian economies as a group, where professional sesector employment offers premium compensation by comparison with manufacturing jobs. Thesecases suggest that the structural transformation process should focus on the quality of service seemployment, including skill content, productivity, and the commitments to education and traineeded for this.

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Figure : Share of Gross Domestic Product in Manufacturing,

DMC developing member country, GDP gross domestic product, HiInc Asia high-income ADB members,Lao PDR Lao Peoples Democratic Republic, PRC Peoples Republic of China.



Figure : Gross Domestic Product and Employment Shares in Manufacturing,


Notes: Solid circles depict GDP shares in each country, while the hollow circles indicate employment shares. Countries/regions are lisorder of increasing per capita income. Horizontal axis depicts annual per capita real GDP. Bubble size is proportional to population.

Source: Authors estimates from the Global Trade Analysis Project based at Purdue University.

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We cannot omit services from consideration in any long-term development and growth stuIn light of the fact that OECD economies get about two-thirds of their employment and income fthese activities, a service-intensive economy is often seen as the destination for an Asian structtransformation since it began in earnest about years ago and continues today. Our results sugthat productivity growth and policy facilitation can be quite congenial to accelerated service semployment and output, but financial liberalization is particularly so. Not only is finance an impservice sector in its own right, it can be argued that service sector investment is among the easieexpand from national to regional markets. We see in Figure that regional financial integratipotent catalyst for service-intensive growth and structural transformation.

Figure : Output Growth in Services( change from baseline in )

DMC developing member country, HiInc Asia high-income ADB members, Lao PDR People Democratic Republic,PRC Peoples Republic of China.


Figure summarizes the initial conditions for service sector GDP across the Asian re

Here we clearly see that, in value-added terms, the share of economic activity accorded to servicebe quite large even for low-income countries. This does not contradict the basic paradigm of structransformation, but we need to qualify our understanding of service sector employment in termreal wages. It is not the real size of the service sector in aggregate GDP that determines strucprogress, but the per capita returns to employment in each sector. Thus, low-income countries mhave high GDP shares, but these wages remain below levels needed for middle class emergenceself-sustaining, consumption-driven domestic growth.

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Figure : Share of Gross Domestic Product in Services,




Figure : Service Sector Gross Domestic Product and Employment Shares,


Notes: Countries/regions are listed in order of increasing per capita income. axis depicts annual per capita real GDP. Bubble size isproportional to population.


Other DMCs

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Figure puts services in a per capita GDP perspective, revealing again the importance osector to livelihoods at all stages of development. Just as agriculture is an underachiever in determaverage living standards, services generally contribute much more than the average to GDP on capita worker basis. As mentioned in reference to manufacturing above, this means services mremain a very high priority for skill-intensive labor market policies. As we can see across this spectrum of Asian economies, this fact remains true before, during, and after industrialization.

To summarize regional structural conditions, Figure depicts GDP shares for the iscenario year . Countries in this figure, arranged vertically, by increasing per capita GDP. Hsee basic features of structural transformation across the diverse region. Thus, the lowest-incocountries generally have the highest share of GDP in agriculture, middle-income countries are industry dependent, and higher-income countries have large service sector GDP shares.

Figure : Initial ConditionsShare of Real Gross Domestic Product,

DMC developing member country, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democratic Republic,PRC Peoples Republic of China, Mfg manufacturing, Serv services.

Source: Global Trade Analysis Project based at Purdue University, www.gtap.org.

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As was already observed, however, GDP shares are not sufficient indicators of stagdevelopment, especially for services. To better understand the latter, we need to take accountemployment, as it explains the per capita wage component of value added. A relatively large sesector can reflect a massive service sector labor force working for subsistence wages in one counta smaller, highly skilled professional labor force in an OECD economy. Figure containsimportant insights regarding structural transformation. First, we see the dominance of agriculemployment directly associated with lower-income status.

Figure : Initial Conditions: Employment Shares,

Agr agriculture, DMC developing member country, HiInc Asia high-income ADB members, Lao PDR Lao Peoples DemocraRepublic, PRC Peoples Republic of China, Mfg manufacturing, Serv services.

Source: Global Trade Analysis Project based at Purdue University.

Second, manufacturing as a percent of total employment is not a useful indicator of sectors contribution to living standards. These results show that industrial employment is abousame percentage in Pakistan and Sri Lanka as in the PRC, but we know that structural transition isadvanced in the PRC because jobs in this sector are more skill and education-intensive, with h

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productivity and wages that reflect this fact. This means the quality of structural transformatioultimately be just as important as labor resource shifts, absolute job creation, and migration.

Figure offers a more revealing picture of sector contributions to living standards, andcan be expected from continued structural transformation in the Asian region. The quantitmeasured here, GDP share minus employment shares, are a general macro indicator of how mlabor in each of the three structural sectors (agriculture, manufacturing, services) contributesnational income. Thus, we see in all but Other DMC that agriculture contributes less to GDP themployment, meaning that average wages (and attendant productivity) in agriculture are chronibelow economywide averages. In this way, large pools of labor in agriculture can be seen as a dgrowth.

Figure : Initial Conditions: Gross Domestic Product and Employment Shares,

Agr agriculture, DMC developing member country, HiInc Asia high-income ADB members, Lao PDR Lao Peoples Democra

Republic, PRC Peoples Republic of China, Mfg manufacturing, Serv services.Source: Global Trade Analysis Project based at Purdue University.

Conversely, we see that in most economies, manufacturing employment is an above-aver(per capita worker) contributor to GDP. There are a few important exceptions in both low-inco(India and Sri Lanka) and high-income countries where industrial wages are inferior to average ssector compensation. These two categories define the bookends of structural transformationfrlow-wage, unskilled services to higher, education-intensive professional labor. To a significant e

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then, we see that structural transformation is as much about the qualitative characteristics of servsector labor as it is about the intermediate stage of industrialization.

Finally, we examine the dynamic scenarios from a structural perspective, asking how mchange can be expected and why. Figure shows the changes that can be expected in real shares for the Asian economies considered under the most dynamic scenario of regional finaliberalization (i.e., FDI). In all countries, agriculture will see its share decline even though abagrifood output will continue to rise over the entire period . We know this is a fundacharacteristic of structural transformation, and it will continue at different paces and in diffedegrees across the region.

Figure : Change in Real Gross Domestic Product Shares,



We see from the relatively mixed share changes for manufacturing and services that thernothing inevitable about the OECD model of service-intensive transition, at least over the nedecades. Service sector GDP will be salient in of Asian economies, but manufacturing GDfastest growing in Malaysia, Viet Nam, Thailand, and the PRC, respectively. These results reveessential insights regarding structural transformation in the region during the period considered.

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the speed of transformation will vary considerably, and up to years from now, some economistill be in the primary or secondary stages of development. This is a result not only of initial condwhich we already know are very diverse in Asia, but of the two main drivers of growth, domestexternal demand.

It is essential to recognize that demand patterns are the primary determinant of structutransformation. Policy and supply-side factors (resources and enterprises) play a supporting roledemand is the only force that can ultimately sustain patterns of resource allocation and investmFor Asia, these patterns will be quite specific to economies and their initial conditions, and both pand enterprise agency must take account of this. Figures and summarize these patterns fordomestic and external (export) demand for all Asian economies we consider, and the differeelucidate what potential exists in the medium term to facilitate structural change nationally regionally.

Figure : Shares of Domestic Demand for Domestic Output,



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Figure : Shares of Real Export Demand,

Agr agriculture, DMC developing member country, HiInc Asia high-income ADB member countries, Lao PDR Lao PeoplesDemocratic Republic, PRC Peoples Republic of China, Mfg manufacturing, Serv services.


For all the countries considered, in real value terms, domestic demand is already dominateservices (except in the PRC), while exports are dominated by manufacturing. The PRmanufacturing emphasis is primarily the result of intermediate demand for export production, ivery manufacturing dominant (Figure ). What these demand patterns mean as a practical matthat a given economys potential for structural change will depend on the pace and magnitudgrowth in domestic and external demand. Countries with large and growing internal markets will more rapidly toward a service-intensive economic structure. Those that are highly dependentexports for growth will be pushed in the direction of industrialization.

Obviously, the relative importance of domestic and external demand will depend on bdomestic purchasing power and trade orientation. Lower-income countries, which have lodomestic demand capacity and want to leverage external demand for growth, will be drawn toindustrial structure. High-income countries can sustain large-scale demand for services, reinforstructural transformation toward a postindustrial economic order. Middle-income and transit

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economies, such as the PRC and Thailand, will draw economic orientation from both sourcedemand, and here policy could have a decisive influence on structural transformation.

Ultimately, the lesson from these results is that structural transformation is driven by demand differentiated by source. Domestic demand, after meeting basic agrifood needs, is serintensive. Export demand for most of the Asian region is manufacturing intensive. The relinfluence of these two forces in a given economy depends on their scale and pace of growth.example, a small low-income economy might be driven toward industrialization by dynamic eopportunities. A high-income Asian economy may also export (even with very high manufactintensity like high-incomeAsian economies), but the depth of its domestic demand prevails ovreinforcing its status as a postindustrial, service-oriented economy.

Figure : Change in Export Shares,

Agr agriculture, DMC developing member country, HiInc Asia high-income ADB members, Lao PDR Lao Peoples DemocraRepublic, PRC Peoples Republic of China, Mfg manufacturing, Serv services.Source: Global Trade Analysis Project based at Purdue University.

Although initial conditions suggest that manufacturing for export will be a primary drivAsian regional growth, the long-term forecasts reveal structural changes that will shift the compoof output, employment, and value-added growth across the region. In particular, Figure showsrising Asian incomes will strongly stimulate agrifood trade growth, a process already well docum

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by ADB and other research institutions.7 For example, Jha et al. ( ) estimate that agrifood trade the region will nearly double by , and here we see that trend continuing through the next deto .

The implications of agrifood-intensive export growth are particularly important to lowincome Asia. Many of these economies lack the population densities and domestic savings needepass through a diversified industrialization phase. Expanded agrifood trade thus offers them grleverage, but it is essential to meet this demand with higher domestic productivity and expanvalue-added creation. Without policies to achieve this, agrifood growth will not realize its potentdomestic livelihood improvement, as farming remains a low-wage activity for rural poor populati

Agrifood trade is bound to expand as emerging Asia increases its urban populations incomes rise in large economies. Without domestic agricultural progress in low-income counhowever, this trade growth will merely increase regional inequality. Higher-income countrieimport basic agricultural commodities, capturing most of the value added in the food supply chain

Figure : Change in Domestic Demand Shares,

Agr agriculture, DMC developing member country, HiInc Asia high-income ADB member, Lao PDR Lao Peoples DemocratRepublic, PRC Peoples Republic of China, Mfg manufacturing, Serv services.


7 It should be noted that, although agricultures share of exports increases for most countries, absolute exports of altypes (agriculture, manufacturing, and services) increase for all economies over the period considered.

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Middle Income

High Income

Low Income

Other Income


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During the same period, the second main driver of growth, domestic demand, will becmore service intensive (Figure ). This process, in response to rising incomes, is the classical strchange seen around the world and the dominant characteristic of OECD (so-called postindustreconomies. The superior growth of services holds promise for all the regions economies, as histowe have seen that tertiary activities contribute more to GDP than to total employment (i.e., osuperior wages) at all stages of development. Each regional government can enhance the econobenefits of service sector expansion by promoting higher productivity (education, training, etc.) aas facilitating private investments to the same end (regional integration, financial liberalizationforeign direct investment promotion).

As we have seen so many times in the Asian region, there is no one size, pathway, or destination that applies to all. Policy must be adapted to take best advantage of individcircumstances. However, despite the diversity of Asian economies, two aspects of future growth significant gains to any Asian economies that can implement the policies needed to capture themexport growth, particularly in agrifood, can significantly improve the prospects of lower-incomeeconomies and lower-income people across the entire region, as long as productivity and value acan be increased; and (ii) service sector growth, in response to domestic demand, can enha

aggregate and per capita GDP growth with more determined public and private investmenteducation and training. Among the most important enabling policies will be more open multilaterand more efficient regional financial integration.

VI. LABOR MARKET IMPACTS

Employment development, both in terms of absolute job creation and job quality, is a primdeterminant of livelihoods in emerging markets and therefore a primary consideration policymakers. Because this region is so diverse in terms of initial labor market conditions, it wotempting to conclude that no single policy could be generalized for national implementation acAsia. In fact, our results suggest that a small number of human resource issues and economic poare of very general applicability, if one measures economic progress by the standards of high wag job creation. We review the results of our scenario analysis from both perspectives in this section.

A. Wages

Job creation is necessary for social stability and progress, but it is not sufficient in low-inccountries. As rural populations inexorably transit to nonrural areas, labor services become the source of wealth for populations in Asia. For this reason, policies that enhance average wages beever more important to improving overall livelihoods. As economic theory tells us, and the resuTable clearly indicate, factor productivity is a primary determinant of real wages.

Thus, the successful Asian economies have been technology-driven and continually strivinupgrade the skills of their populations. The benefits of this human resources approach to growthdevelopment become even more pronounced with the application of regional policies that faciltrade and capital flows. Thus, we see that national investments in human resources can contributgrowth, but their full potential can only be realized with complementary financial investment. Ttrue regardless of the source of the investment, a fact that should not be ignored by countries have not committed fully to a favorable investment climate. In these circumstances, every public spent on human capital is underperforming without the complementary private dollar to enhaproductivity, directly via on-the-job training and indirectly via technology infusion.


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Table : Average Wage Growth( change from baseline in )





Other income Other DMCs All Asia

DMC developing member country, FLib financial liberalization, HiInc Asia high-income ADB Members, Infr infrastructure iKProd improvements in production technology, Lao PDR Lao Peoples Democratic Republic, LProd improvements in labor proTLib trade liberalization, TProd total factor productivity growth.

Note: Countries/regions are listed in order of increasing per capita income.


Conversely, countries th

Documents

Growth Horizons for a Changing Asian Regional Economy