Morgan Stanley's Daniel Lian: Pivotal Elections in Southeast Asia

Pivotal Elections in Southeast Asia
Daniel Lian (Singapore)

Three Southeast Asian countries held elections this year. After the general election in Malaysia, concluded in March, Indonesia went to the polls in April to elect a new national legislature and local governments and the Philippines elected a new president and half the Senate in May. Indonesia is also scheduled to vote for a new president in July. These are pivotal elections as they usher in new economic and political leadership that will affect future economic development and improved political stability in Southeast Asia.

On June 24, the Philippine Congress declared President Gloria Macapagal Arroyo the winner of the May 10 election. Ms. Arroyo secured a six-year unambiguous mandate, thus ending her “indirect ascent” to the presidency – as in the prior 3½ years she had assumed the presidency from former President Estrada after he was overthrown in January 2001. On July 5, Indonesia will, for the first time, directly elect its president from a pool of five candidates.

Challenging Social-Economic and Geopolitical Risks

The Indonesian and the Philippine elections are pivotal. Both have large populations – 219 million and 82 million, respectively, and their combined population is more than three quarters of the almost 400 million people in the five ASEAN economies. Both face considerable economic and geopolitical risks, and both are “non-investment grade,” with lowest rankings on various economic metrics among the “market-oriented” economies in East Asia. Relative economic underdevelopment, the inequitable distribution of income and wealth, high unemployment and poverty, coupled with poorly developed institutions and deep-rooted rent-seeking behavior by governments, corporates and other elites create considerable problems.

Social discontent and geopolitical challenges are evident in both economies, and in some instances, this has led to the establishment of radical Islamic movements. There are about 210 million Muslims in the five major Southeast Asia economies. In Indonesia, they are 184 million, or 85% of the estimated 219 million population, but in the Philippines a much smaller 7 million, or 9% of the 82 million population. I believe governments need to deal with the level of discontent among the underprivileged in both economies to avoid disillusionment with the established secular democracies and reduce the appeal of radical Islamic groups.

Economic Challenges

The new leaderships in Indonesia and the Philippines must confront considerable economic challenges.

(1) Skin-deep industrialization and the fallacy of China-trade induced prosperity: While both economies have pursued FDI-driven mass manufacturing export orientation and are fairly successfully in generating export growth, their manufacturing production base and exports remain extremely low value-added and are vulnerable to competition from China and other low-cost economies.

While many point to the recent surge in two-way trade between both countries and China, as well as the robustness in intra-Sino-Southeast Asian trade, as the prelude to a mutually beneficial and symbolic structural relationship, I believe the optimism is misplaced. The economic reality is that China cannot be a major growth factor for both countries, in my view. Exports to China accounted for only 6.2% of Indonesia’s merchandise exports and 6% of Philippines in 2003. Also China does not actively invest in both countries.

China’s substantially enlarged two-way trade and growing deficits with ASEAN in the past few years suggest neither economic advantage nor strength in the ASEAN traded sector. In my view, this signals that Southeast Asia is rapidly losing its traditional export markets to China, while at the same time surviving by exporting parts to China to fulfill the world’s appetite for Chinese goods on terms drawn up by multinational corporations. The rapidly growing two-way trade and Chinese trade deficits are increasingly characterized by China buying more mass-manufactured parts (heavily concentrated in IT-related sectors) and primary products (agriculture, commercial crops and commodities) from ASEAN.

(2) Consumption dependency and inadequate saving and investment: Both Indonesia and the Philippines persistently have the lowest national saving and domestic capital formation rates in the region. FDI trends have also been the most negative among East Asia peers in recent years.

While I have consistently endorsed a more balanced dual track model to boost domestic demand and balance excessive dependence on high saving, wasteful government and crony corporate-led investment, and the “lack of pricing power” for mass-manufactured exports, both economies are not saving or investing enough. While they should pursue more second track development to engineer structural resilience in domestic demand, the correct route is through more productive investment rather than consumption.

(3) Weak government finance and heavy debt: A major reason for inadequate saving and investment rates, other than capital and intellectual capital flight, and a poor political economy, is their structurally weak government finance positions and the concomitant excessive public and external debt burden. Other East Asia governments have considerable debt but also possess significant assets and large foreign reserves.

(4) The lack of a well-thought out rural platform and long-term economic development strategy: I believe both economies have few prospects to win the global FDI game in the near future, and thus the low-value generic mass manufacturing export model will not bring sufficient economic growth and prosperity. It is thus critical for policymakers to establish a well thought out rural development platform to better leverage their vast and less developed rural sector – Indonesia’s population is 58% rural and the Philippines is 41%. Both economies also need to map out a long-term development blueprint with a strengthened platform to address the long-term needs of the urban poor, and the resource, SME and the government and corporate sectors.

In my view, Thailand’s dual-track development strategy has a lot of relevance for both of these largely agrarian economies.

Political-Economy and Other Structural Impediments

The challenges confronting both economies stretch beyond economic parameters. In my view, the leaders in both countries must strive to overcome two common structural impediments:

(1) Ineffective government institutions vs. an institutionalized rent-seeking complex: In both countries, public institutions are not strong and there is a well-entrenched rent-seeking complex that dominates the corporate and government spheres, leaving most of the population without much economic or social mobility.

(2) Capital and intellectual capital flight: Substantial domestic savings are overseas and the top echelons of talent are not serving the domestic economies and institutions.

Bottom Line: Rural Development Platform

The presidential election just concluded in the Philippines, and the presidential election that is set to unfold in Indonesia are pivotal for two of the less developed economies in Southeast Asia. Both countries face substantial social, economic and geopolitical risks. The primary economic challenges are that both economies have attained only skin-deep industrialization and are overly dependent on consumption for growth as both nations lack savings and investment. The low-saving and investment trap is in no small part due to weak government finances and a heavy debt burden. Beyond economic parameters, both economies face the common impediments of a strong institutionalized rent-seeking complex, ineffective public institutions, and severe capital and intellectual capital flight.

In my view, both economies have few prospects of winning the global FDI game in the near future and concomitantly the low-value generic mass manufacturing-based export model will not bring sufficient economic growth and prosperity that are desperately needed to circumvent low growth, high debt and poverty traps. It is thus critical for their policymakers to establish a well thought out rural development platform to better leverage their vast but underprivileged and less developed rural sectors. Both countries also need to map out a long-term development blueprint with a strengthened platform to address the long-term needs of the urban underprivileged, resources, SMEs, and the government and corporate sectors.